Here’s what the biggest Fed rate hike in 28 years means for you

The Federal Reserve raised its target federal funds rate by 0.75 percentage points, the biggest increase in nearly three decades, at the end of its two-day meeting on Wednesday in a bid to contain runaway inflation.

“The motivation for all of this is that prices are going up,” said Chester Spatt, professor of finance at Carnegie Mellon University’s Tepper School of Business. “The Fed is trying to fight that with higher interest rates to reduce demand.”

The latest move is just part of a cycle of rate hikes, which aims to crush inflation without tipping the economy into a recession as some fears may arise. The Fed last raised rates 75 basis points in November 1994.

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“It’s been 22 years since they’ve raised rates by more than a quarter of a percentage point and now to do so in back to back meetings, it really speaks to the urgency at hand,” said Greg McBride, chief financial analyst at Bankrate.com.

For consumers, this aggressive approach could eventually bring relief from soaring prices. It also has a cost.

What the Federal Funds Rate Means to You

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

“We’re definitely going to see the cost of borrowing go up pretty quickly,” Spatt said.

Amid rising rates and future economic uncertainty, consumers should take specific steps to stabilize their finances, McBride added — including paying off debt, especially expensive credit cards and other high-rate debt. variable, and increasing savings.

Pay off high-interest debt

Since most credit cards have a variable interest rate, there is a direct link to the Fed’s benchmark, so short-term borrowing rates are already rising.

Credit card rates are currently 16.61%, on average, significantly higher than almost all other consumer loans and could approach 19% by the end of the year – which would be a new record high, according to Ted Rossman, senior industry analyst at CreditCards. .com.

If the APR on your credit card reaches 18.61% by the end of 2022, it will cost you an additional $832 in interest charges over the life of the loan, assuming you’ve made minimum payments on the loan. average balance of $5,525, Rossman calculated.

If you have a balance, try consolidating and paying off high-interest credit cards with a low-interest home equity loan or personal loan, or switch to a balance transfer credit card without interest, he advised.

Consumers with variable-rate mortgages or home equity lines of credit may also want to switch to a fixed rate, Spatt said.

Since longer-term 15- and 30-year mortgage rates are fixed and tied to Treasury yields and the broader economy, these homeowners won’t be immediately affected by a rate hike.

However, the average interest rate on a 30-year fixed-rate mortgage is also on the rise, hitting 6.28% this week, up more than three percentage points from 3.11% at the end of December. .

“Given they’ve already risen so dramatically, it’s hard to say how much mortgage rates will rise by the end of the year,” said Jacob Channel, senior economic analyst at LendingTree.

On a $300,000 loan, a 30-year fixed rate mortgage would cost you about $1,283 per month at 3.11%. If you paid 6.28% instead, it would cost $570 more per month or $6,840 more per year and $205,319 more over the life of the loan, according to Grow’s mortgage calculator.

Even though auto loans are fixed, payments go up because the price of all cars goes up, so if you’re thinking of financing a new car, you’ll be shelling out more in the months ahead.

Federal student loan rates are also fixed, so most borrowers won’t be hit immediately by a rate hike. However, if you have a private loan, those loans can be fixed or have a variable rate tied to Libor, Prime, or Treasury bills – meaning when the Fed raises rates, borrowers are likely to pay more interest. , although how much more will vary by reference.

This makes it a particularly good time to identify outstanding loans and see if refinancing makes sense.

Look for higher savings rates

Although the Fed has no direct influence on deposit rates, they tend to be correlated with changes in the target federal funds rate. As a result, the savings account rate at some of the largest retail banks is barely above the floor, currently just 0.07%, on average.

“The rates paid by the big banks are largely unchanged, so where you have your savings is really important,” McBride said.

Thanks in part to reduced overhead, the average online savings account rate is closer to 1%, well above the average rate at a traditional bank.

“If you have money in a savings account earning 0.05%, moving it to a savings account earning 1% is an immediate twenty-fold increase, with more benefits to come as interest rates are rising,” according to McBride.

The best-performing certificates of deposit, which yield around 1.5%, are even better than a high-yield savings account.

However, since the rate of inflation is now higher than all of these rates, any money saved loses purchasing power over time.

To that end, “one of the main opportunities is the ability to buy US government I bonds,” Spatt said.

These inflation-protected assets, backed by the federal government, are almost risk-free and pay an annual rate of 9.62% until October, the highest return on record.

While there are purchase limits and you can’t mine the money for at least a year, you’ll get a much better return than a one-year savings account or CD.

What’s next for interest rates

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

Although the Fed has already hiked rates several times this year, more hikes are on the horizon as the central bank grapples with inflation.

While expectations for these increases had been quarter- and half-point increases at each meeting, the central bank could grant further increases of 50 or 75 basis points if inflation does not start to pick up. to calm down.

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