Fed Reserve Rate Hike Impact?

During the Covid-19 epidemic, we often heard about the Federal Reserve decreasing their rates, which widely made money cheaper across the economy. We saw cheaper interest rates for auto loans, mortgage loans, credit cards, student loans and all around cheaper money to help protect the economy. The biggest negative impact was savings accounts paying out very low interest rates. 

Since early in 2022, all we have heard is the opposite. It has been widely reported that inflation has been skyrocketing, so the Federal Reserve has been quickly increasing interest rates to try and slow down inflation. When consumers go to the grocery store, the price of simple items like a dozen eggs has nearly tripled in price. Loaves of bread, milk, butter, fruits and vegetables and basic foods of survival have double in some circumstances. In attempts to slow down the high inflation, the Federal Reserve continued to increase interest rates through all of 2022. There is talk they will continue to do it in early 2023 and if they do, how do higher rates impact important financial areas of life?

Mortgage Loans

Fixed-rate mortgage tend to move in the same direction as the Federal Reserve's Federal Funds Rate, but they are not directly tied to it. They are more closely tied to the Treasury yields. Treasury yields are much more forward looking and in some cases, mortgage rates can start to decrease if the general market believes inflation is slowing down and coming to an end with the coming Federal Reserve rate hikes.

Adjustable-rate mortgages and Home Equity Lines of Credit (HELOCs)  -are actually tied to the prime rate, which is directly controlled by the actions of the Federal Reserve increasing or decreasing rates. So if the Federal Reserve decides to keep increasing rates, a Home Equity Line of Credit can adjust every time the Federal Reserve hikes rates higher, making the loan more expensive every hike. Adjustable-rate mortgages will also be tied, but in many cases they can only increase once a year and have caps on the adjustments. Federal Reserve rate hikes will still make the adjustable-rate mortgage more expensive over time.  

Auto Loans

Auto loans to purchase a new or used vehicle are also tied to the prime rate, which is tied to the hikes from the Federal Reserve. Auto loans are fixed-rate loans, so once you are in the loan, you cannot be impacted by increasing rates. Those impacted are those shopping for a new vehicle for their household.  If you were buying a car at the beginning of 2022, the average interest rate was 3.96% and the average interest rate on a five-year new car loan now is 6.18%. 

Credit Cards

Credit cards have a variable interest rate so as the federal funds rate increases, so does the prime rate and credit card rates are tied to it. It normally takes somewhere between 1 to 2 billing cycles until the higher rate is applied to the credit bill. Over the last year, credit card rates have risen at the quickest pace in history and the average credit card rate is now at 19.9%. If the Federal Reserve continues to increase interest rates, credit card rates will continue to historic highs each time.

From late 2021 until late 2022, the average consumer had a 15% higher balance of credit card debt, mostly due to the increase of inflation and consumers trying to find ways to pay for higher costs. There are economists that are predicting financial turmoil since credit card balances are rising at the same time credit cards rates are hitting record highs.

Student Loans

Federal Student Loans are fixed-rate loans and are not immediately impacted when the Fed increases rates.  They tend to move similar to auto loans. Federal student loans in place will not be impacted, but students that take on new federal student loans will likely have higher interest rates after the rate hikes.

Private student loans are the opposite. They tend to be adjustable interest rates, which means when the prime rate and Treasury bill rates increase, student loan payments and and amount of interest increase within 1 to 2 billing cycles.  In the short-term, federal education debt is still paused, so they still have 0% until the Education Department announces the end of the pause, which is expected to happen some time in 2023.

Savings Accounts

Here's the one area that is likely a positive when the Federal Reserve increases the federal funds rate. The Fed has no direct control over rates paid on savings deposits by banks, but rate changes tend to align with the actions of the Fed. Savings accounts paid historic lows during Covid-19, but have increased similar to the Fed increasing rates over the last year.

The downside is that savings account rates have gone up and some of the top-yield accounts are paying a little above 4%, but inflation rates have been nearly double that over the last year so that money is not keeping up with inflation.

Homeowners carrying credit card debt and home equity line of credit debt, may want to consider paying it off if they have equity since mortgage rates have been trickling down and rates on other debts have been increasing with the Federal Reserve hikes.

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