Economic Insider

Interest rates are on the rise again: 4 ways it affects people

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Interest — In an effort to combat inflation, the Federal Reserve raised the target federal funds rate by a quarter point this week. The Federal Reserve’s Federal Open Market Committee hiked interest rates to a targeted range between 5.25% to 5.5%. As a result, the target rate midpoint has risen to its highest level since 2001.

Despite recent indications that inflationary pressures have abated, the central bank kept interest rates constant at its most recent meeting, warning that price-control efforts are far from complete.

Inflation is presently over the Fed’s 2% target. However, according to Brett House, an economics professor at Columbia Business School, “It’s entirely possible that this could be the last hike in the cycle.”

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Federal fund rates

The Federal Reserve Bank of the United States is responsible for calculating the federal funds rate, which is the interest rate at which banks lend and borrow money to one another overnight. Although the federal funds rate is not the rate paid to customers, the Fed’s actions have a significant influence on the borrowing and saving rates  seen on a daily basis.

The current interest rate hike is the Federal Reserve’s 11th, with the first being in March 2022. It is also associated with an increase in the prime rate, which quickly raises financing costs for various forms of consumer borrowing. As a result, it makes escaping a later recession more difficult for households.

“The pain that the rate hike has caused for a lot of people isn’t gratuitous,” said House.

“Ultimately, this is a trade off in choices between pain now and greater pain later if inflation isn’t brought under control.”

How the higher interest rates affect you

Mortgage rates remain high

Because 15- and 30-year mortgage rates are now set and related to Treasury yields and the economy, homeowners will not be affected immediately by the interest rate increase. In contrast, inflation and the Federal Reserve’s monetary policies discourage people from seeking for new homes. According to Freddie Mac, the average 30-year fixed-rate mortgage rate is presently less than 7%.

When the increased interest rates are included into mortgage rates, homeowners will pay an additional $11,160 over the life of the loan. Other forms of mortgages, on the other hand, are more closely associated with the Fed’s operations.

Adjustable-rate mortgages and home equity lines of credit are linked to prime rates. A HELOC may be changed quickly, however most ARMs are only updated once a year. The average HELOC rate is already 5.8%, according to Bankrate, the highest in 22 years.

Student loans shoot up

Because federal student loan rates are set, rate changes will have no effect on the vast majority of borrowers. Undergraduate students who get new direct federal student loans beginning in July, on the other hand, will be penalized with a 5.50% interest rate for the 2022-2023 school year.

For the time being, any customers with an active federal student loan can take advantage of the 0% interest rate, although student loan payments will begin in October.

Private student loans may contain variable interest rates linked to Libor, implying that students may pay more in interest if the Fed raises interest rates.

Car loans become harder to attain

Despite the popular belief that auto loans are fixed, payments are rising as automobile prices rise in tandem with new loan interest rates.

According to Edmunds, the average rate on a five-year new car loan is presently 7.2%, the highest in 15 years. Paying an annual percentage rate of 7.2% instead of 5.2% in 2022 may cost consumers $2,278 more in interest over the life of a $40,000, 72-month vehicle loan.

“The double whammy of relentlessly high vehicle pricing and daunting borrowing cost is presenting significant challenges for shoppers in today’s car market,” said Edmunds’ director of insights Ivan Drury.

Credit cards reach record highs

Credit cards are intrinsically connected to the Federal Reserve’s benchmark due to their variable interest rates. Within one or two billing cycles, as the federal funds rate rises, so do the prime rate and credit card rates.

The average credit card interest rate has risen by more than 20% and now stands at an all-time high. Meanwhile, credit card balances are increasing, and more than half of all credit card users are in monthly debt.

“It’s still a tremendous opportunity to grab a zero percent balance transfer card,” said Bankrate chief financial analyst Greg McBride.

“Those offers are still out there, and you have credit card debt, that is your first step to give yourself a tailwind on a path to debt repayment.”

A silver lining

While there appear to be only negatives, there are some benefits, such as higher savings account interest rates.

Although the Federal Reserve has no direct influence over deposit rates, adjustments in the Fed’s target federal funds rate are frequently linked to them. Savings account rates at a number of major retail banks touched rock bottom during Covid. They are presently, however, averaging 0.42%.

Because of lower administrative costs, top-yielding online savings account rates are presently around 5%, the highest since the 2008 financial crisis.

McBride, on the other hand, warned that if this is the final rate rise for a while, interest rates may eventually decrease.