How the Fed’s interest rate hike could affect your money

Fed Chairman Jerome Powell testifies before Congress. Photo of Federal Reserve Board Chairman Jerome Powell by Chip Somodevilla/Getty Images Image:

In a Nutshell

The Fed is raising its benchmark interest rate. We know this can be confusing, so Credit Karma is here to explain how it will affect your wallet.

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The Federal Reserve’s decision to raise interest rates for banks will increase the cost of borrowing for millions of consumers.

New Federal Reserve Board Chairman Jerome Powell announced Wednesday that the Fed would raise the federal funds rate by a quarter-point to a target range of 1.5% to 1.75%. In September, the Fed announced plans to raise interest rates two more times in 2018, so this increase isn’t a surprise.

How will the Fed rate hike affect your finances?

The Fed’s interest rate hike directly impacts banks, but could also have a trickle-down effect on the prices consumers pay to borrow money.

A lot of folks think a rise in interest rates is bad for the economy, because it makes the cost of borrowing higher, but it also makes it easier to borrow money

Ric Edelman, personal finance expert

If you carry a balance on a credit card, mortgage, or a student or auto loan with a variable interest rate, you could end up paying a little more each month. While the increases may be small, it’s still money that’s not in your pocket.

On the bright side, if you’re struggling to qualify for credit, the Fed’s interest rate hike may make it easier to borrow money.

“A lot of folks think a rise in interest rates is bad for the economy, because it makes the cost of borrowing higher, but it also makes it easier to borrow money,” says Ric Edelman, a personal finance expert.

When interest rates go up, the number of consumers applying for loans tends to decrease because it becomes more expensive to borrow money.

When loan volume decreases, sometimes banks will loosen their underwriting standards a little to try to boost loan volume and keep their bottom line steady.

Here’s what you need to know.

How do interest rate changes work?

The Federal Reserve’s Federal Open Market Committee meets eight times each year to determine the nation’s monetary policy.

Based on the Fed’s review of the country’s economic outlook, the committee can decide whether to change the federal funds rate. This is the rate banks charge one another to borrow money.

When the Fed decides to raise interest rates, banks typically respond by raising the prime rate. The prime rate is the interest rate that commercial banks charge consumers who have been deemed to be at the lowest risk of defaulting on loans.

People with less healthy credit scores, who may therefore be viewed as a riskier bet for banks, may pay higher interest on loans than their prime peers.

Because of this, when the prime rate moves, it has a direct impact on the adjustable interest rates of many consumer-facing loans such as mortgages and credit cards.

How will the rate hike affect my money?

If you have an adjustable-rate mortgage, credit card or loan, or plan to get a variable- or fixed-rate version of these products, changes in interest rates could affect you. Here’s a product-by-product breakdown of the potential impact.

  1. Credit cards
  2. Mortgages
  3. Student loans
  4. Auto loans
  5. Savings accounts

Credit cards

You could notice a slight increase in credit card interest rates. Most credit cards charge variable interest rates that are calculated by adding a percentage to the prime rate. So as the prime rate rises, you may see an increase in your variable rate.

Credit Karma crunched the numbers and found that the Fed’s quarter-point interest rate hike could cost credit card users more than $2 billion in additional interest charges. According to a November report by the Federal Reserve Bank of New York, consumers owe $808 billion in credit card debt. We multiplied that number by the Fed’s quarter-point (0.0025) interest rate hike to figure out the impact it will have on consumers.

That’s a big number, but let’s look at how this might affect you.

Suppose you’re making the minimum payment of $25 on your $1,000 credit card debt with an interest rate of 18.99%.

It’ll cost you nearly $600 in interest charges and take you more than five years to pay off your debt. But if your interest goes up a quarter-point, you’ll end up paying only an additional $16 in interest.

The moral of the story? You’ll do your wallet a big favor by not carrying a credit card balance, regardless of what the Fed does to interest rates.

“Though your variable interest rate will probably increase, you’ll only be impacted if you carry a balance on your credit card,” says Patty Cathey, an investment advisor with Smart Retirement Plan.

“If you have high-interest credit card debt, you should focus on paying it off sooner rather than later to avoid higher interest charges.”

If you pay your bill in full and on time every month, the increase in interest rates shouldn’t change anything for you.

However, “If you regularly carry a balance and are worried your interest charges could get more expensive, consider applying for a balance transfer card with a lower interest rate or zero-percent introductory APR offer, which could save you on interest over a fixed period of time,” Cathey says.

Keep in mind, though, that you’ll probably need good to excellent credit to be approved for one of these cards.

It’s also important to note that the small fraction of credit card users who pay fixed interest rates might not be affected by fluctuations in the prime rate.

Mortgages

The Fed’s hike in the federal funds rate could mean a similar increase in your interest rate, if you have an adjustable-rate mortgage.

But keep in mind, just because the Fed has increased the federal funds rate by a quarter percent doesn’t necessarily mean your mortgage will increase by the same amount. In many cases, the increase will be minimal.

Let’s look at how this might affect a typical homeowner.

“If you take out $200,000 for a 30-year mortgage at 4%, your monthly payment would be $954,” says Robert Baltzell, president of RLB Financial, a financial consulting firm in California. “If your interest rate went up 0.25%, you would then be paying an additional $29 per month, for a total monthly payment of $983.”

For most homeowners, that $29 increase is manageable, but it’s still money that won’t be in your pocket.

Many mortgages limit the amount your interest rate can change. You can ask your loan provider or check your loan agreement to find out whether this is the case for you.

In addition, your adjustable rate is only partially tied to interest rates such as the prime rate. Mortgage rates have traditionally changed in line with domestic 10-year Treasury notes, which are mainly affected by inflation rates — so the change in the Federal Reserve rate is only one factor.

If your adjustable rate is going to increase, your mortgage servicer is generally required to notify you.

Depending on whether your interest rate has been adjusted before or not, you may be given anywhere between two and eight months’ notice, so you’ll have time to prepare for the rate increase or look for a new loan.

If you have a fixed-rate mortgage, your mortgage won’t be affected by the Fed rate hike since your interest rate is set. But if you plan to get a fixed-rate mortgage soon, you might be affected.

Student loans

College graduates may also be affected by the Fed’s interest rate hike.

If you have a federal student loan that was disbursed after July 1, 2006, it should be a fixed-rate loan, meaning the Fed rate hike won’t affect you.

But if your federal loan was disbursed before this date, it probably has a variable rate, so you may see an increase in your rate and should contact your loan servicer for more information.

Many private student loans also come with variable interest rates. But the increase will likely be gradual, so you shouldn’t necessarily be concerned that your monthly payment is going to skyrocket right away.

For a college graduate who is paying off $30,000 in student loans over the next decade, a quarter-point hike in your interest rate translates to a $3 increase in your monthly payment.

If you’re finding your student loan repayments challenging, you also may have the option to refinance into a fixed-rate loan that isn’t subject to change — but you typically need excellent credit to qualify for refinancing.

Auto loans

Your car payment could also go up.

If you have a fixed-rate loan, your monthly interest payment won’t change because of the increase in the interest rate.

But if you have a variable-rate loan, your monthly interest payment will likely increase. Keep in mind, you may hardly feel an increase in the interest rate.

For example, with a five-year, $25,000 loan at 5% APR, you’ll pay $472 per month. If your loan provider passes along the entirety of the 0.25% increase in the federal funds rate to you, your monthly payment will only jump $3, to $475 per month.

This small increase could pose a problem if you’re “upside down” on your car loan — meaning you owe more on your car than it’s worth — since now your loan could cost even more.

Savings accounts

It’s not all bad news, though — an interest rate hike could mean good news for savers, Cathey says.

Banks may increase interest rates for savings accounts, checking accounts and certificate of deposit accounts, meaning money that you’ve placed in an interest-bearing account could receive a higher rate of return.

You shouldn’t expect a major increase in your savings rate, though — banks aren’t contractually obligated to pass on the rate increase to you, so the increase you could see may be minimal.

Mika Bhatia contributed to this article.