How the interest rate hike could impact your money

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How the interest rate hike could impact your money

By MIKA BHATIA

On December 14, Federal Reserve chairwoman Janet Yellen confirmed ongoing speculation that the Fed is raising interest rates.

At its last meeting of the year, the Fed announced that the federal funds rate -- the rate that banks charge each other for short-term loans -- would be increasing a quarter point to a target range of 0.5 percent to 0.75 percent. The Fed also plans to raise interest rates three more times in 2017.

How might the rate hike impact your finances? Here's what you need to know.

How do interest rate changes work?

Eight times a year, a governing body called the Federal Open Market Committee (FOMC) meets to determine monetary policy for the Federal Reserve. At these meetings, the committee can decide whether to change short-term interest rates based on their review of the country's economic outlook.

If the FOMC decides to change interest rates, there's a trickle-down effect: Banks usually respond by readjusting the prime rate - the interest rate they offer to their customers with the strongest credit. Given a higher prime rate, banks will also likely raise interest rates for their other consumers.

How the rate hike could affect your money

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

Mortgages

The increase in the federal funds rate could mean an increase in your interest rate if you have an adjustable rate mortgage (ARM).

However, just because the Fed has increased the federal funds rate by a quarter percent doesn't automatically mean your mortgage will increase by the same amount.

For one, many ARMs 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 like the prime rate. Mortgage rates have traditionally changed in line with 10-year Treasury notes, which are mainly affected by inflation rates -- so the change in the federal reserve rate is only one indirect factor.

If your adjustable rate is set 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 impacted.

According to Patty Cathey, an investment advisor with Smart Retirement Plan, "The average rate on a 30-year fixed-rate mortgage has jumped in the past few weeks, and it's only expected to rise with the Federal Reserve increasing interest rates."

Credit cards

You could also see an increase in your credit cards' interest rates.

Most credit cards offer variable APRs - interest rates that are calculated by adding a percentage to a "reference rate" such as the prime rate. As the prime rate is expected to increase, you may also see an increase in your variable APR.

The increase won't necessarily be immediate -- it depends on how often your provider updates your rates, which might be monthly or quarterly (you can call your card issuer or check your account agreement to find out when your rate may change).

It's possible your credit card has a fixed interest rate, though these are rare. But a fixed rate might not be as "fixed" as you'd think -- most providers write into your agreement the right to change your rate in certain situations, like if market conditions change. They just have to notify you in writing first.

So although your fixed rate isn't determined by the prime rate, you may still want to check with your card provider to see if you should expect any changes.

"Though your variable (and possibly fixed) interest rate will probably increase, you'll only be impacted if you carry a balance on your credit card. If you have high-interest credit card debt," Cathey says, "you should focus on paying it off sooner rather than later to avoid higher interest charges.

If you pay your bill in full 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 0 percent introductory APR offer, which could save you on interest over a fixed period of time," Cathey says.

You'll probably need good to excellent credit to be approved.

Student loans

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

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.

If you have a private loan, it may come with a variable rate, so your interest rate will likely go up. But the increase will likely be gradual, so you shouldn't necessarily be concerned that your monthly payment is going to skyrocket right away.

You also may have the option to refinance your loan into a fixed rate loan that isn't subject to change - however, you typically need to have excellent credit to qualify for refinancing.

Auto loans

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

If you have a variable rate loan, which is less common, your monthly interest payment will likely go up. However, because car loans tend to be longer term loans with many payments spread across a period, you might hardly feel an increase in the interest rate.

For example, with a five-year, $30,000 loan at 3 percent APR, you'll pay $539 per month. If your loan provider passes on the entirety of the 0.25 percent increase in the federal funds rate to you, your monthly payment will only jump $3, to $542 per month.

This small increase could pose a problem if you're "upside down" on your car loan -- you owe more on your car than it's worth -- since now your loan could cost even more.

Between January and September of this year, one-third of car trade-ins toward the purchase of a new car were "upside down," according to Edmunds.com.

Savings accounts

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

Banks may increase savings rates, meaning money that you've placed in an interest-bearing savings 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.

About the Author: Mika Bhatia is a Staff Writer for Credit Karma. She's worked in financial services and tech, and has now found the perfect union of the two at Credit Karma. When she's not busy coming up with credit-related analogies, she's most likely supporting the Warriors, enjoying a fine cup of British tea or doing yoga (goal: completing a headstand without toppling over). Follow her at @MikaBhatia!

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