The Federal Reserve on Wednesday announced it will raise short-term interest rates by three-quarters of a percentage point, the largest interest rate hike in 28 years.
The move, aimed at bringing down a 40-year high inflation number, will hit Americans’ wallets in a number of ways.
Wednesday’s rate hike comes after two others initiated by the Fed this year — a 0.25% hike in March and a 0.5% move in May. More rate hikes, a 0.75% increase in July, followed by two 0.5% hikes in September and November, are expected.
How does the rate hike affect your finances? Here’s what we know now.
First, what is the Fed?
The Federal Reserve, or “Fed,” is the central banking system of the United States. Its purpose is to regulate the money supply by keeping prices stable (controlling inflation) and maintaining full employment.
What is the federal funds rate?
The federal funds rate, or the “Fed rate,” is the interest rate that banks charge each other to borrow money overnight.
It’s done overnight so as to meet federal regulatory requirements and to be ready to manage market conditions in the morning.
Now, how do the rates affect your life?
Mortgage rates have gone up since last fall when the Fed announced its intention to hike rates.
That trend will likely continue. The rate on Tuesday, 6.28% for a 30-year fixed rate, is the highest it has been since 2008. The rate dropped a bit on Thursday.
“Mortgage rates are definitely going to go up over the next few weeks,” Matthew Pointon, senior property economist at Capital Economics, told The Wall Street Journal.
Just how high they will do is not clear.
“Given that they’ve already gone up so dramatically, it’s difficult to say just how much higher mortgage rates will go by year’s end,” Jacob Channel, senior economic analyst at LendingTree, said.
How does a rate increase affect the cost of a home mortgage?
If you have a $300,000 loan, at a 30-year fixed rate of 3.11% — the interest rate that was being charged in December — you would pay around $1,282 a month.
That same loan with a 30-year fixed rate at 6.28% (Tuesday’s average rate) would cost an extra $571, making your monthly payment $1,853 a month, according to Grow’s mortgage calculator.
Credit card interest rates follow the prime rate, or the interest rate that banks use as a basis to set rates for different types of loans and lines of credit. That means credit card interest rates will be going up, according to Bankrate.com.
While credit card interest rates are tied to the prime rate, the prime rate is typically 3 percentage points above the Fed funds rate — the rate increased on Wednesday.
“With the frequency of Federal Reserve rate hikes this year, it will be a drumbeat of higher rates for cardholders every couple of statement cycles,” Greg McBride, chief financial analyst at Bankrate.com, told The New York Times. “And the cumulative effect is growing. If the Fed raises rates by a total of 3 percentage points this year, your credit card rate will be 3 percentage points higher by the first of the year.”
The rate has gone up from 16.34% in March to the current rate of 16.73%.
While credit card rates are tied to the prime rate, car loans tend to track the five-year Treasury rate. That rate is also influenced by the federal funds rate.
The Treasury rate refers to the current interest rate that investors earn on debt securities issued by the U.S. Treasury.
However, with car loans, other factors work to determine the cost of a loan such as a down payment, a buyer’s credit score, the type of vehicle and other factors.
A borrower’s credit history, the type of vehicle, loan term and down payment are all baked into that rate calculation.
An increase in the Fed rate can mean higher yields for savers.
When you save money in a bank, you are essentially allowing the back to borrow your money. You lend them money and they pay you interest in return.
As the Fed rate goes up, banks may increase rates on savings accounts to attract new customers.
Click here for some tips on what to do with savings accounts.
If the stock market takes a dip as it has done in the past weeks, your 401(k) account is likely to take a hit if you have a large number of stocks in your portfolio.
However, if you have retirement money coming from fixed-income investments, you can see the interest on those investments rise.
What will the rate hike cost you in dollars?
Every 0.25% increase in the Fed’s benchmark interest rate equals an extra $25 a year in interest on $10,000 in debt.
In other words, the 0.75% increase the Fed initiated on Wednesday means an extra $75 of interest for every $10,000 you have in debt.
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