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Federal Reserve hikes interest rates 0.25% for the first time since 2018: What that means for your money

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Key Points
  • As inflation runs rampant, the Federal Reserve announced its first interest rate hike since 2018 to curb rising prices.
  • When the Fed raises interest rates, "it makes money more expensive," says Greg McBride, chief financial analyst at Bankrate. "In a nutshell, higher interest rates will act as a brake on the economy and reduce demand, and that's where you get lower prices."

The Federal Reserve announced its first interest rate hike of 0.25 percentage points on Wednesday afternoon. This is the central bank's first rate hike since 2018, and one of several projected in 2022 and 2023.

When the Fed raises interest rates, "it makes money more expensive," says Greg McBride, chief financial analyst at Bankrate. Essentially, it raises the price banks charge other banks to lend money. In general, the Fed raises interest rates to try to tamp down inflation, which is currently at a record high.

On the flip side, when the Fed wants to stimulate the economy, it reduces interest rates, which is why the target rate range has been between zero and 0.25% since early 2020, as the Covid-19 pandemic took its toll on the economy.

Here are some of the ways a rate hike can affect you.

Borrowing money gets more expensive

When the Fed raises interest rates, interest rates on all sorts of financial products can rise too, some more so than others.

Credit card interest rates are especially sensitive and tend to jump up quickly. "Since the Fed is expected to hike rates a few times, your credit card APR could go from 16% to 18% in a year or two," says McBride. "Be mindful" because those two percentage points could make it that much harder to dig out of debt.

When it comes to auto loans, "rates will go up, but it's nothing to lose sleep over," McBride says. A interest rate increase, "has a pretty minimal impact on affordability. If somebody's looking at a $25,000 car loan, the hike will mean $3 more a month so that's not really going to be much of a headwind for car buyers."

Mortgage rates aren't directly correlated, but "based on longer-term interest rates and those longer-term interest rates tend to move well in advance of short-term interest rates," McBride says.

In anticipation of the Fed's rate hike, mortgage rates have already increased by a full percentage point since the beginning of the year, McBride says. "By the time the Fed moves, mortgage rates have long reflected it."

Goods and services may cost less, eventually

Raising interest rates is one of the Fed's only tools to stifle record inflation. Here's how it works: When it's more expensive to borrow money, fewer businesses take out loans and economic growth slows. When businesses aren't expanding and growing, they'll lower prices to boost demand.

"In a nutshell, higher interest rates will act as a brake on the economy and reduce demand, and that's where you get lower prices," McBride says.

Savers may be rewarded

If you're saving money, you might earn more interest on whatever you've stashed away, whether that's in a savings account or a CD.

That said, "where you have your money is going to be very important. Not all banks are going to be quick to pass along higher rates," McBride says.

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Short-term bumpiness in the stock market is 'inevitable'

Stocks are not directly affected by rising rates, but "for investors, volatility is an inevitable byproduct of changing interest rates," McBride says. "Over the long term, patience and discipline are rewarded as the economy grows and corporate profits increase."

If you're a long-term investor, sticking with a well-diversified portfolio of stocks, bonds, and some cash will produce better results than trying to time the market, McBride says.

And it's important to remember this rate hike "is not a one and done. [It's] the first of several interest rate increases," McBride says. "We're starting from very low interest-rate levels, so this will just be reversing interest rate cuts that the Fed put into effect at the onset of the pandemic."

Don't expect prices to change overnight, McBride adds: "It's going to take a lot of rate hikes to bring inflation down."

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