What a Fed rate hike means for ordinary Americans

US dollar notes are seen in a Nov 7, 2016, picture illustration.
US dollar notes are seen in a Nov 7, 2016, picture illustration.PHOTO: REUTERS

(WASHINGTON POST/CNN) - The Federal Reserve raised its benchmark interest rate yesterday (Dec 14) by a quarter of a percentage point — the second rate hike in about 10 years.

Last year’s rate increase, the first since 2006, offered a few lessons for consumers wondering how the move might affect mortgages, car loans, saving rates and other parts of their personal finances.

The biggest lesson is that a single rate increase on its own may not make much of a difference, analysts say. If the Fed continues to move slowly, as it has been, it may be a while before you see a change in mortgages, savings accounts and other accounts. But if officials raise the key short-term rate more regularly, the effects could be more dramatic.

Trying to guess exactly what the Fed will do is a loser’s game.

“Not even the Fed knows how far and how fast interest rates are going to go up,” says Alan MacEachin, corporate economist at Navy Federal Credit Union.

But here are a few things to keep in mind about how the Fed’s move may affect your wallet:

Mortgages

Anyone about to purchase or refinance a home tends to become anxious about the Fed raising rates. But history shows there’s actually very little correlation between the Fed’s benchmark interest rate and 30-year fixed-rate mortgages.

Mortgage rates, which are more closely tied to the rates on long-term bonds, such as the 10-year Treasury bond, can go up and down for a number of reasons. Take a look at what happened last year, when the Fed raised the federal funds rate by 0.25 percentage points. Mortgage rates moved slightly higher initially, then fell for six straight weeks. They fell even further after some major events, such as Brexit, sent more investors piling into Treasury bonds, which are typically viewed as safe havens during times of uncertainty.

 

Rates have been rising again recently, especially since the election. The average rate on 30-year fixed-rate loans went from 3.47 per cent in late October to 4.13 per cent last week. But that run-up put rates roughly back where they were last year before the Fed’s rate increase. 

Most experts expect rates to increase more moderately in the coming year. Mike Fratantoni, chief economist at the Mortgage Bankers Association, is predicting home loan rates won’t go up much more than they already have.

“We expect that the 10-year Treasury rate will stay below 3 per cent through the end of 2018,” he said, “and 30-year mortgage rates will stay below 5 per cent over the same period.”

Main takeaway: Don’t rush to buy a home because you think interest rates are going to go up. Even if rates keep rising, the change is expected to be gradual.

Car loans

A second rate hike from the Fed shouldn’t have a huge impact on the price of your car, says Jack Nerad, executive market analyst for Kelley Blue Book, a car research website.  For example, on a US$25,000 (S$36,000)  loan, an interest-rate bump of 0.25 percentage points would increase interest charges by about US$5 a month. 

Car loans ticked up a tiny bit after last year’s increase, and a similarly small change may happen this time around, Nerad says. (Average rates for five-year loans on new cars rose from 4.34 per cent to 4.4 per cent a few weeks after the rate hike last year before coming back down, according to Bankrate.com.)

But most people will find that what really drives the cost of their car is not what the Fed does but whether they negotiated to get a lower price, says Greg McBride, chief financial analyst at Bankrate.com. Likewise, having poor credit can lead to a higher interest rate and more costs overall, he says.

Main takeaway: Instead of stressing over the Fed, focus on boosting your credit score and researching prices so that you can haggle to get a good deal.

Credit cards 

This is one of the rare areas where a Fed rate hike could be felt right away. That’s because the rates on credit cards and other lines of credit, such as home equity loans, are directly affected by the Fed, credit experts say. 

If the Fed raises interest rates by 0.25 percentage points, the rate on your credit cards should increase by that much within one or two statement cycles, McBride says. But while a single rate increase can lead to slightly higher credit card rates, it may not add much to your debt load. 

Multiple rate hikes, however, could start to make a difference. Average credit card rates increased only slightly over the past 12 months, from 15.8 per cent on Dec 16, 2015 — the date of the last Fed increase — to about 16.3 per cent last week, according to Bankrate.com.

Main takeaway: If you’re trying to pay off debt, keep making big payments now on the chance that rate increases will continue. The best move would be to pay your card off in full each month.

Savings accounts

The last rate hike didn’t bring any relief to savers, and this rate increase probably won’t either. 

Many banks and credit unions may wait until the Fed’s benchmark interest rate is a little bit higher before they start passing along those rates to savers, McBride says. He says one issue is that many financial institutions are already holding a lot of cash, so they don’t have much of an incentive to attract more deposits by offering higher rates on savings accounts.

Instead, some banks and credit unions may keep saving rates low while they slowly increase the rates they charge on credit cards, mortgages and other loans, he says. Then, after several rate increases, they may move to raise the rates on savings accounts and certificates of deposit.

Main takeaway: The best way to find better yields on savings accounts is to shop around and compare rates from credit unions, small banks and online banks. “Don’t expect those returns to fall in your lap,” McBride says.

Fed hike likely won't end the Trump market rally

Stock markets used to tremble at the mere hint of a Fed rate hike. When the Fed raises rates, that increases borrowing costs for companies, strengthens the dollar and it can cool down spending plans. All those can factors can pinch profits.

But Trump's promise to rev up infrastructure spending and lower corporate tax rates has US stock markets at all-time highs. And just about everyone - 97 per cent of investors - believed a rate hike was coming on Wednesday, so it wasn't a shocker.

However, if the Fed starts raising rates faster than expected next year, the stock market's glory ride could hit some bumps as borrowing costs rise and the dollar gets stronger.

A strong dollar tends to make US products like iPhones more expensive - and less attractive - to foreign buyers.

All to say: Investors may be biting their nails if there are indications that rates may rise faster.

Trump may have to handle a hawkish Fed in 2017

The President-elect's big spending plans could drive up demand for all types of goods. Higher demand could increase the pace of inflation, which has been very sleepy the last few years and a big reason why wage growth has been low.

If inflation gets going, the Fed could raise rates faster to keep up with it.

Along with home mortgages, higher rates increase the interest on credit card payments and auto loans. That could cool spenders' appetite. Consumers make up the majority of economic activity in America.

Still, rates are historically still very low. The Fed has tried to prop up the economy since the Great Recession with super low interest rates. Trump called it a "false economy" during his campaign.

In any case, the burden of sparking stronger economic growth is shifting to Trump from the Fed. The central bank's role will diminish as the government action will pick up. Trump promises to rebuild America's roads, bridges and tunnels.

But both sides are certainly looking at different crystal balls. Trump is promising 4 per cent annual growth. The Fed is projecting 2 per cent annual growth until 2019.