As the world expected, U.S. Federal Reserve policy makers today raised the short-term, benchmark federal funds rate for the first time since 2006, lifting it from a range of “0 to 0.25 percent” to “.25 to .50 percent.”
The Fed’s rate had been at “near zero” since December 2008 in order to stimulate growth during the financial crisis and Great Recession, and throughout the slow but relatively steady economic recovery of the past five years.
The move is slight, but policy makers separately project a rate of 1.375 percent by the end of 2016, potentially indicating four quarter-point increases over the next year. And major banks have already begun raising their “prime rate,” or base rate for consumer loans, by a quarter percentage point, or .25 percent. Loans carrying a variable rate tied to the prime rate will be immediately affected.
In one way or another, sooner or later, the Fed’s rate hike, although only a quarter of a percent for now, will affect most U.S. consumers who borrow money. That includes anyone with a credit card, a mortgage, a car loan, a student loan or a range of available personal loans via traditional banks or upstart online lenders. Because of the rate hike’s ripple effect, investors in stocks and bonds will also need to keep a close eye on their portfolios.
Here’s a rundown on the degree of impact today’s Fed rate hike will have on typical consumer financial products.
1. Fixed-Rate Mortgages and auto loans: Not much change for now; rates still historically low.
The so-called “big ticket” financial products, mainly fixed-rate mortgages and auto loans, won’t feel the affect of the Fed’s first short-term rate hike right away. (Variable-rate mortgages will likely start rising in the short-term). Overall, even fixed-rate mortgages are poised to gradually increase over the next year — likely over 4 percent on average for the 30-year fixed loan. Borrowers have enjoyed fixed mortgage rates in historically low territory for five years or so. Currently, the 30-year average is just under 4 percent.
In comparison, mortgage rates ten years ago were closer to 6.5 percent and 20 years ago 7.0 percent. The Fed sets the target rate for very short-term debt. But it also influences interest rates on longer-term debt like mortgages and car loans.
Consumers shopping for new or used vehicles might see slightly higher rates over the next few months. But rates on auto loans and leases should not increase substantially, especially for borrowers with good-to-excellent credit. U.S. auto sales have been on a record run this year. Even a slight bump in loan rates might slow down the momentum.
2. Credit cards: Likely yes, so keep balances low to zero.
Credit card borrowers are most susceptible to changes in the federal funds rate. Credit card issuers routinely charge rates — as do providers of adjustable-rate mortgages and home equity lines of credit — that are pegged to the prime rate. And the prime rate moves with the federal funds rate. Prime is 3.25 percent today, and many credit card issuers add a certain percent on top of the prime to set the annual percentage rate, or APR.
For those borrowers who keep credit card balances low, or even better, pay them off regularly, a 0.25 percent increase in an APR is not a big issue. But for those who carry a balance month to month, the higher rate affects the full balance, including new purchases.
3. Student Loans. Yes, but it depends on whether they’re private or federal, and whether they’re based on market-pegged variable rates. For most borrowers, the Fed rate hike will have no effect on their federal student loan rates. The reason: federal student loans paid out since July 1, 2006 carry a fixed interest rate, meaning the rate on the loan is already set for the entire term of the loan. But fixed rates on new federal student loans are determined according to a formula based on the auction of 10-year Treasury notes each year for loans disbursed on July 1 through the following June 30. If the market has pushed up the rate on these short-term Treasuries, then you will see a bump up in rates, but it will likely be a marginal move.
Many borrowers with federal student loans paid out before July 1, 2006, face variable rates. That means the interest rates on those loans fluctuate based on a market benchmark rate. So there will also be a slight impact for them as well. Student borrowers who opted for the private market could also see slightly higher rates, especially if those loans carry variable rates also tied to a market benchmark.
4. Savings bank accounts. Yes. And that’s welcome news for savers.
The big positive about a Fed rate hike is its impact on savings accounts or certificates of deposit, which have earned almost zero interest in the last seven years. That should begin to change over the next year or two, although gradually. However, big banks won’t offer customers higher interest on savers’ deposits right away, experts say. It will likely take one to two years to feel the impact. So savers, be patient because there’s a higher rate of return at the end of the rainbow for that sunny day.
5. Stocks and bonds. The markets might get a little volatile for a while.
If you invest in stocks and bonds — as many Americans do via their 401(k)s — a Fed rate hike will definitely have an impact on your portfolio. It warrants a consult with your financial adviser on the right mix of stocks and bonds moving forward, as the Fed decides to gradually raise rates over the next year. The Fed’s moves could fuel volatility in both stock and bond markets, which are already feeling the highs and lows of market jitters.