The Federal Reserve’s decision to raise its benchmark interest rate on Wednesday, the fifth increase since the financial crisis, will probably reach beyond Wall Street and into most American homes.
Anyone with a credit card will see a small but instant shock to their interest rate, followed by borrowers with student and auto loans and, eventually, mortgage holders.
At the Fed’s final meeting of the year, and the last one for Janet L. Yellen, its chairwoman, the board of governors set the target federal funds rate between 1.25 percent and 1.5 percent, a quarter-point increase.
The psychological effect of the increase, the third of 2017, may be dulled as consumers grow conditioned to the such moves.
But more are coming. The economy seems healthy, with low unemployment and the promise of stimulus measures like the Republican plan to cut taxes. Fed policymakers are raising the rate to prevent the economy from overheating, and expect three more increases in 2018.
Continue reading the main storyEthan S. Harris, an economist with Bank of America Merrill Lynch, cautioned in a note to investors that “there is no such thing as a painless Fed hiking cycle.”
Credit Cards
Credit card debt is already expensive, with interest rates at more than 13 percent on average, according to Fed data. The latest rate increase could make using plastic slightly pricier.
Unlike homeowners and other borrowers, cardholders are immediately affected by an increase. Card rates are based on a bank’s prime rate, which is usually set at 300 basis points, or three percentage points, above the high end of the Fed’s benchmark. Cardholders pay a premium above the prime rate that is determined largely by their creditworthiness.
That final rate tends to be variable, allowing banks to make adjustments when their own borrowing costs increase. This could cause payments to balloon, because credit cards tend to compound interest, requiring consumers to pay interest on their base balance and on the accrued interest.
The average American household that carries credit card debt has a balance of about $15,650, according to a recent analysis by the personal finance website Nerdwallet. After a quarter-point increase in the Fed’s rate, each household can expect to pay an average of $919 a year in credit card interest, up from $904, according to the study. Further Fed increases would push card rates higher.
Consumer groups suggest that debtors who cannot pay off their monthly credit card balances transfer the debt onto a card that does not charge interest for several months, and then clear the amount owed before the card switches to a variable rate.
Mortgages
Home loans usually come with 15- to 30-year terms, a far longer timeline than the short-term borrowing affected by the federal funds rate.
So mortgage rates, which have hovered below 4 percent for much of 2017, are less sensitive to incremental rate increases than to changes in the yield of the 10 year U.S. Treasury note, which stayed low this year even as the Fed rate ticked up.
Fixed rates on 30-year mortgages largely track the Treasury movements. From June 2004 to June 2006, when the Fed raised the federal funds rate 17 times, mortgage rates followed a similar pattern.
Homeowners are not entirely shielded from the impact of a Fed rate increase. Whenever the central bank makes borrowing costlier for commercial banks, those institutions have an incentive to pass those costs on to customers.
The most vulnerable borrowers are those either seeking a new mortgage or already holding one with an adjustable rate. Lenders have begun gradually pushing up rates, partly in anticipation of future Fed increases.
If mortgage rates increase, Americans may be less inclined to buy homes. Lighter demand could mean lower home prices. Homeowners with fixed-rate mortgages may hold off on refinancing, leading to less loan activity and trouble for workers in the industry.
Student loans
Students who already have a fixed-rate government loan will not see a change, but the interest rates on private variable-rate loans will probably rise because of the Fed’s action. Those who anticipate borrowing for college in the near future may see an uptick in rates.
Federal loans are tied to the rate on the 10-year Treasury note, which accounts for future shifts in the Fed benchmark rate. The government adjusts its loan rates each July.
Private lenders can be expected to raise variable rates on personal loans, but the shift for most existing borrowers will not happen until the date specified in their master promissory note.
“When there’s a hike in the rate, you’ll typically see a hike throughout the whole private lending world as well,” said Ashley Norwood, a consumer and regulatory adviser with American Student Assistance, a nonprofit group assisting student borrowers. “In normal years, the increases aren’t significant enough to be alarming — an extra $2,000 over the course of a 20-year, $30,000 loan isn’t making or breaking you usually.”
But repeated rate increases, she said, could cause “heartburn,” especially for vulnerable borrowers with lower credit scores.
Auto loans
Similar forces are at work for car owners, although the impact is far more muted than it is for credit card and student loan holders. Monthly payments on new auto loans might be just a few dollars more than for existing debtors.
Auto loans have been relatively affordable for some time, with banks offering interest rates below 4.5 percent for both four- and five-year terms, usually with fixed, rather than variable, rates.
Eight in 10 new car sales are financed through a dealer, bank affiliated with an automaker or lease, said Jessica Caldwell, a senior analyst at Edmunds. Automakers and dealers are accustomed to dangling hefty incentives that they sweeten during downturns and the holidays.
Although 17.2 million new cars are projected to be sold in 2017, dealers have experienced a drop-off since last year, Ms. Caldwell said. Dealers have sizable inventory of current-year models to offload before 2018 and might temporarily ignore the effect of the Fed increase.
“When sales are going down, there’s more pressure for automakers and dealers to keep market share,” Ms. Caldwell said. “When things are very competitive, they’re more willing to eat the cost by offering low-interest-rate financing even if they have to pay more for their loans.”
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