Late last year, for the first time in almost a decade, the Federal Reserve raised its benchmark lending rate, the amount banks and credit unions charge to lend reserve money to other financial institutions overnight.
Why does this matter to you?
The rate increase is a good sign overall. It indicates the U.S. economy has healed significantly since the Great Recession and no longer needs the crutch of extremely low interest rates to keep going.
But it may have mixed results for you personally. Here’s why.
While the hike in the Federal Reserve’s benchmark (or “fed funds”) rate was small—just 25 basis points, from a range of 0 to .25 percent to .25 to .5 percent—it could make a big difference in how much you end up paying on any money you owe. That’s because lenders typically tie it to the interest rates they charge borrowers.
Within 24 hours of the Fed rate increase, several major banks announced they were raising the prime rate to 3.5 percent from 3.25 percent. (That’s the amount charged to borrowers with the best credit; lenders then add a premium to that for others, depending on how creditworthy they’re deemed.)
That means that if you have variable-rate credit card or private student loan debt, your rate just went up. (Federal student loans carry a fixed rate, but private student loans generally base variable rates on the Libor index, which tends to track the fed funds rate.) And if you have an adjustable-rate mortgage, your payment is likely to go up the next time the rate adjusts.
On the bright side, “interest rates, even after the increase, are still rock bottom,” says Ryan Sweet, director of real-time economics at Moody’s Analytics. “Most consumers won’t feel the effects of the first few rate hikes.”
Now that we’ve seen one interest-rate bump, “the proverbial ball has begun to roll,” says Scott Cousino, Certified Financial Planner and president of Legacy Capital Planners in Grand Rapids, Mich. “We should expect ongoing upward movement for some time.”
The Fed committee is scheduled to meet eight times this year and could raise rates as many times, though it probably won’t. (At it’s meeting on January 27, for example, the Fed decided to hold rates steady.)
“The cycle can be very slow,” says Sweet, who predicts we’ll see consistent bumps of about 25 basis points each quarter in 2016, and that, ultimately, the Federal Reserve’s benchmark rate will hit about 2 percent by the end of 2017.
In other words: The variable interest you’re paying on your credit card balance could go up by that much in the next two years.
Cousino notes that savings accounts and CDs will eventually earn more interest. But probably not as much you think.
While many banks announced an increase in the rate they’d charge borrowers right after the Federal Reserve raised its rate, they announced no corresponding increase in the rate they’d pay on deposits (like the money in your savings account).
Why not? Simply put: Because they don’t have to. Increases on the rate you’ll get in a savings or money market account typically lag increases in loan rates—and since most banks have plenty of money in reserves now, they have little incentive to raise the interest they pay. If savers start pulling their money out of savings accounts and banks want to attract more money, that may change. But it’s not likely to happen anytime soon.
A report by the Federal Reserve found that deposit rates (for example, on savings, checking and money market accounts) adjust about twice as frequently when federal funds rates are falling than they do when rates are rising. In other words: Banks are quick to cut the interest they’ll pay you on your savings account but slow to increase it.
Many homebuyers get a 30-year fixed-rate mortgage, which is not directly tied to the Federal Reserve rate. Over time, though, long-term mortgage rates are likely to increase gradually from current rates, which are near historic lows. And as they do, fewer people may decide to take out mortgages.
In the short term, however, Sweet predicts the opposite, as on-the-fence buyers may jump in before rising rates push prices out of their comfort zone.
So if you’re in the market to buy or sell, it may make sense to follow their cue.
Experts project negligible effects from the rate hikes for the stock market, since investors have been anticipating rate increases for a while (assuming they happen gradually). But, of course, no one has a crystal ball.
“Stock markets are historically sensitive to uncertainty, and looming continual rate increases along with a contentious presidential election cycle [could] create a fair amount of volatility in the U.S. equity markets for 2016,” Cousino says.
But don’t let that spook you. Investing is a long-term game, so it’s important to stay the course—keeping your money in a diversified portfolio for the smoothest ride—regardless of what happens in the markets in the short run.
What you should act on? Hacking away at your debt as quickly as possible—before it becomes an even heavier weight on your shoulders. As if you needed another reason to rid yourself of that ball and chain.
This story has been updated to reflect the outcome of the January 27 Federal Open Market Committee meeting.