Americans who have long enjoyed the benefits of historically low interest rates will have to adapt to a very different environment as the Federal Reserve is likely to hike rates over a longer period of time to fight inflation.
The record-low mortgage rates below 3%, which were reached last year, are already gone. Credit card interest rates and auto loan costs are also likely to rise. Savers may get somewhat better returns depending on their bank, while the returns on long-term bond funds will likely be lower.
The Fed’s opening quarter-point rate hike Wednesday will not have an immediate impact on the finances of most Americans. But with inflation hitting a four-decade high, economists and investors expect the central bank to implement the fastest pace of rate hikes since 2005. This means that there will be higher lending rates well into the future.
On Wednesday, the Fed’s policymakers indicated collectively that they expect to raise its key rate up to seven times this year, raising its benchmark rate to between 1.75% and 2% by the end of the year. Officials expect four additional hikes in 2023, which would leave their benchmark rate closer to 3%.
Chair Jerome Powell expects that by gradually making borrowing more expensive, the Fed will be able to cool demand for homes, cars and other goods and services, thereby slowing inflation.
Yet the risks are high. With inflation likely to remain high, partly due to Russia’s invasion of Ukraine, the Fed may now have higher borrowing costs than expected. Doing so could potentially push the US economy into recession.
“The impact of a quarter-point interest rate hike is irrelevant to the household budget,” said Greg McBride, chief financial analyst at Bankrate.com. “But there is a cumulative effect that can be quite significant on both the household budget. as well as the broader economy.”
Here are some questions and answers about what rate hikes could mean for consumers and businesses:
I am considering buying a house. Will Mortgage Rates Continue to High?
They have already over the past few months, partly in anticipation of the Fed’s move, and will probably continue to do so.
Even so, an increase in mortgage rates is not necessarily accompanied by an increase in the Fed’s rate. Sometimes they even move in the opposite direction. Long-term mortgages track the rate on a 10-year Treasury note, which, in turn, is affected by a variety of factors. These include investor expectations for future inflation and global demand for US Treasuries.
Global turmoil, like the Russian invasion, has often prompted a “flight to safety” reaction among investors around the world: many rush to buy Treasuries, considered the world’s safest asset. Higher demand for the 10-year Treasury would lower its yield, which would then drive down mortgage rates.
For now, however, sharp inflation and strong US economic growth are sending the 10-year Treasury rate up. According to mortgage buyer Freddie Mac, the average rate on a 30-year mortgage has risen nearly a full percentage point since the end of December, to 3.85%.
How will this affect the housing market?
If you are looking to buy a home and are frustrated by the paucity of homes available, which has led to a bidding war and eye-watering, this is not likely to change anytime soon.
Economists say higher mortgage rates will discourage some potential buyers. And average home prices, which are rising at about a 20% annual rate, may be rising at least as slowly.
But Odetta Kushi, deputy chief economist at First American Financial Corporation, noted that there is such strong demand for homes, as the older millennial generation enters their prime home-buying years, that the housing market won’t cool much. Supply not maintained. Many builders are grappling with shortage of parts and labour.
“We will still have a very strong housing market,” Kushi said.
What about other types of loans?
For users of credit cards, home equity lines of credit, and other variable-interest loans, rates will increase at the same rate as the Fed increase, usually within one or two billing cycles. That’s because those rates are based on the banks’ prime rate, which moves in conjunction with the Fed.
Those who don’t qualify for a lower-rate credit card may end up paying more interest on their balances, and the rates on their cards will go up as the prime rate.
Should the Fed decide to raise rates by 10 times or more over the next two years – a realistic possibility – that would boost interest payments significantly.
The Fed’s rate hike doesn’t necessarily mean raising auto loan rates the same way. Car loans are more sensitive to competition, which can slow the rate of growth.
Will I be able to earn more on my savings?
Probably, although not very likely. And it depends on where your savings, if you have them, are kept.
Savings, certificates of deposit, and money market accounts typically do not track the Fed’s changes. Instead, banks capitalize on the high-rate environment to try to thicken their profits. They do this by imposing higher rates on borrowers, without necessarily providing a juicer rate to savers.
This is especially true for large banks now. They have been flooded with savings as a result of government financial support and reduced spending by many wealthy Americans during the pandemic. They won’t need to raise savings rates to attract more deposits or CD buyers.
But there may be other exceptions to those with online banks and high-yield savings accounts. These accounts are known to compete aggressively for depositors. The only catch is that they usually require significant deposits.
If you invest in mutual funds or exchange-traded funds that hold long-term bonds, they will become a risky investment. Typically, existing long-term bonds lose value as new bonds are issued at higher returns.
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