What the Federal Funds Rate Means to You

The federal funds rate, which is set by the US central bank, is the interest rate at which banks borrow and lend to each other overnight. While that’s not the rate consumers pay, Fed decisions still affect the borrowing and savings rates they see every day.

For starters, rising rates will correspond to a rise in the prime rate and will immediately lead to higher financing costs for many forms of consumer borrowing.

On the other hand, higher interest rates also mean that savers will earn more money on their deposits.

What Borrowers Need to Know About Higher Rates

Short-term borrowing rates will be among the first to jump.

“With the Federal Reserve raising interest rates at an unprecedented rate, variable rate debt such as credit cards and home equity lines of credit will be most exposed,” said Greg McBride, financial analyst in chief at Bankrate.com.

Since most credit cards have a variable rate, there is a direct link to the Fed’s benchmark index. As the federal funds rate rises, the prime rate also rises, and credit card rates follow.

Annual percentage rates are currently just above 17%, on average, but could be closer to 19% by the end of the year, which would be an all-time high, according to Ted Rossman, senior industry analyst at CreditCards.com.

That means anyone with a balance on their credit card will soon have to shell out even more just to cover interest charges.

With this rate hike, consumers in credit card debt will spend an additional $4.8 billion in interest this year alone, according to an analysis by WalletHub. Factoring in the March, May, June and July rate hikes, credit card users will end up paying about $12.9 billion to $14.5 billion more in 2022 than they would have does otherwise, WalletHub found.

As rates rise, the best thing to do is to pay off the debt before larger interest payments drag you down.

If you have a balance, try calling your card issuer to ask for a lower rate, consolidate and pay off high interest credit cards with a low interest home loan or personal loan or switch to an interest-free balance transfer credit card. .

“Zero percent balance transfer offers can be a boon for people in credit card debt,” said Matt Schulz, chief credit analyst at LendingTree.

Variable rate mortgages and home equity lines of credit are also indexed to the prime rate, but 15- and 30-year mortgage rates are fixed and tied to Treasury yields and the economy. Yet anyone buying a new home has lost considerable purchasing power, with rates nearly doubling since the start of the year.

On a $300,000 loan, a 30-year fixed rate mortgage at the December rate of 3.11% would have meant a monthly payment of around $1,283. Today’s rate of 5.54% brings the monthly payment to $1,711. That’s $428 more per month or $5,136 more per year and $154,080 more over the life of the loan, according to Jacob Channel, senior economist at LendingTree.

Even though auto loans are fixed, payments go up because the price of all cars goes up along with interest rates on new loans, so if you’re planning on buying a car, you’ll be shelling out more in the months ahead.

According to data from Edmunds, paying an APR of 5% instead of 4% would cost consumers $1,324 more in interest over the term of a $40,000 auto loan over 72 months.

Federal student loan rates are also fixed, so most borrowers won’t be hit immediately by a rate hike. But if you’re about to borrow money for college, the interest rate on federal student loans taken out for the 2022-23 academic year has already dropped to 4.99%, down from 3, 73% last year and 2.75% in 2020-2021.

If you have a private loan, those loans can be fixed or have a floating rate tied to Libor, prime, or treasury bills — meaning when the Fed raises rates, borrowers are likely to pay more interest, although that how much more will vary depending on the reference.

What savers need to know about higher rates

Thana Prasongsin | time | Getty Images

The good news is that interest rates on savings accounts are finally higher after several consecutive rate hikes.

Although the Fed has no direct influence on deposit rates, they tend to correlate with changes in the target federal funds rate and the savings account rates of some of the larger retail banks, which were at lowest since the start of the pandemic, are currently up to 0.10%, on average.

Thanks in part to lower overheads, the best performing online savings accounts have rates of 1.75% to 2%, far higher than the average rate at a traditional bank.

Inflation has to come down substantially for those higher savings returns to really shine.

Greg McBride

chief financial analyst at Bankrate

As the central bank continues its rate hike cycle, these yields will also continue to rise. Yet any money earning less than the rate of inflation loses purchasing power over time.

“Savers are seeing better returns in savings accounts, money markets and certificates of deposit and further rate hikes will support that momentum,” McBride said. “More importantly, inflation needs to come down substantially for those higher savings returns to really shine.”

What’s next for interest rates

Consumers should prepare for even higher interest rates in the coming months.

Even though the benchmark federal funds rate has now returned to its July 2019 level, at the peak of the last cycle, inflation “still sits north of 9%,” McBride said. “We are not at the finish line, and there will be more interest rate hikes to come in the months to come.”

Traders are betting that the Fed will raise rates again at its next meeting in September, then again in November and December before possibly cutting rates in the spring, depending on how economic conditions change.

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