How the Fed’s rate hike will affect Americans’ finances
Record mortgages below 3% are long gone. Credit card rates are likely to go up. The same will apply to the cost of a car loan. Savers could finally receive a return high enough to outpace inflation.
The substantial half-point hike in its benchmark short-term rate announced by the Federal Reserve on Wednesday won’t, on its own, have much immediate effect on the finances of most Americans. But further significant hikes are expected to be announced at the Fed’s next two meetings, in June and July, and economists and investors are predicting the fastest pace of rate hikes since 1989.
The result could be much higher borrowing costs for households in the future, as the Fed battles the most painfully high inflation in four decades and ends a decades-long period of historically low rates.
Chairman Jerome Powell hopes that by making borrowing more expensive, the Fed will succeed in cooling demand for homes, cars and other goods and services and thereby slowing inflation.
Yet the risks are high. With inflation likely to remain elevated, the Fed may need to push borrowing costs even higher than it currently expects. This could tip the US economy into recession.
Here are some questions and answers about what the rate hikes could mean for consumers and businesses:
I AM PLANNING TO BUY A HOUSE. WILL MORTGAGE RATES CONTINUE TO RISE?
Home loan rates have skyrocketed over the past few months, mostly in anticipation of the Fed’s actions, and will likely continue to rise.
Mortgage rates don’t necessarily go up at the same time as Fed rate hikes. Sometimes they even move in the opposite direction. Long-term mortgages tend to follow the yield of the 10-year treasury bill, which, in turn, is influenced by various factors. These include investor expectations for future inflation and global demand for US Treasuries.
For now, however, accelerating inflation and strong US economic growth are pushing the 10-year Treasury rate up sharply. As a result, mortgage rates have jumped 2 percentage points since the start of the year, to 5.1% on average for a 30-year fixed mortgage, according to Freddie Mac.
The rise in mortgage rates partly reflects expectations that the Fed will continue to raise its key rate. But its next rises are probably not yet fully priced in. If the Fed raises its key rate to 3.5% by mid-2023, as many economists predict, the 10-year Treasury yield will also rise much higher and mortgages will become more expensive.
HOW WILL THIS AFFECT THE HOUSING MARKET?
If you’re looking to buy a home and you’re frustrated with the lack of available homes, which has sparked bidding wars and exorbitant prices, that’s unlikely to change anytime soon.
Economists say higher mortgage rates will discourage some potential buyers. And average home prices, which have been climbing at an annual rate of about 20%, could at least rise at a slower pace.
Soaring mortgage rates “will temper the pace of home price appreciation as the price of potential buyers rises,” said Greg McBride, chief financial analyst for Bankrate.
Yet the number of available homes remains historically low, a trend that will likely frustrate buyers and keep prices high.
WHAT ABOUT CAR LOANS?
Fed rate hikes can make car loans more expensive. But other factors also affect these rates, including competition between car manufacturers which can sometimes lower borrowing costs.
Rates for buyers with lower credit scores are the most likely to rise following Fed hikes, said Alex Yurchenko, chief data officer for Black Book, which monitors vehicle prices in the United States. Since the prices of used vehicles increase on average, the monthly payments will also increase.
Right now, new vehicle loans are averaging around 4.5%. Used vehicle rates are around 5%.
WHAT ABOUT OTHER RATES?
For users of credit cards, home equity lines of credit and other variable-interest debt, rates would rise by roughly the same amount as the Fed hike, typically within one or two billing cycles. That’s because those rates are based in part on the banks’ prime rate, which moves in tandem with the Fed.
Those who don’t qualify for low-rate credit cards may end up paying higher interest on their balance. The rates on their cards would increase as the prime rate does.
If the Fed decides to raise rates by 2 percentage points or more over the next two years – a distinct possibility – it would significantly increase interest payments.
WILL I EARN MORE ON MY SAVINGS?
Probably, although unlikely. And it depends on where your savings, if you have any, are parked.
Savings, certificates of deposit and money market accounts generally do not follow Fed changes. Instead, banks tend to take advantage of a higher rate environment to try and boost their profits. They do this by charging higher rates to borrowers, without necessarily offering lower rates to savers.
This is especially true for large banks today. They have been inundated with savings thanks to government financial aid and the spending cuts of many wealthier Americans during the pandemic. They won’t need to raise savings rates to attract more deposits or CD buyers.
But online banks and others with high-yield savings accounts might be an exception. These accounts are known for their aggressive competition for depositors. The only problem is that they usually require large deposits.
Still, savers are beginning to see better potential returns from Treasuries. On Tuesday, the yield on the 10-year note was 2.96%, after briefly above 3% for the first time since 2018.
The financial markets are expecting an average inflation of 2.83% over 10 years. This level would give investors a positive, albeit very small, return of around 0.13%.
“All of a sudden we find ourselves in this position where fixed income securities are much more competitive than before,” said Jason Pride, chief investment officer for Private Wealth at Glenmede.