Following the meeting of the Federal Reserve Board of Governors (FED), the central bank board decided to raise interest rates by 0.25 to 0.5 percent. The decision comes in the frame of rising inflation in the United States, not seen in over 40 years.
With the increase of interest rates, the FED hopes to control, at least partially, the rise in prices that the United States is experiencing at the moment. However, the measure has a trade-off. It will make the cost of borrowing more expensive for all Americans.
Home loans are largely based on the yield of the 10-year U.S. Treasury note. This rate is used as a benchmark for all different types of loans. With the FED raising rates, the interest on a 30-year fixed-rate mortgage has just increased to 4% for the first time since 2019. In 2021, the average rate on a home loan was 3.05%.
In recent years, low-interest rates and low inventory have put upward pressure on the housing market. As of January, the average sales price of a single-family home in the United States stood at $357,100, a 16% increase in less than a year.
Rising interest rates mean higher returns on your savings
During the pandemic, Americans achieved the highest savings rates ever since World War II, due to low spending during the quarantine months and the stimulus checks sent out by both the Trump and Biden administrations.
With an increase in interest rates by the FED, they would, theoretically, increase interest on savings, so Americans would have an incentive to save more with a rise in interest rates.
Generally, low-interest rates mean lower returns for savers, so a rate hike means higher returns, and several banks have even increased their yields on savers’ deposit accounts with the rise of interest rates.
Your credit card debt will be more expensive to pay off
Perhaps credit cards are among the first instruments to feel a rise in interest rates. Normally, before interest rates rise, it is ideal to pay off your credit card debts because the cost of the debt will become more expensive as the FED raises interest rates.
Although banks have full independence in deciding the interest rate charged on loans granted via the credit cards they offer, the interests charged by banks are largely determined by the Federal Funds rate, i.e., if the interest rates set by the FED increase, the interest on credit cards will almost automatically do the same.
For individuals who pay their debts at the end of the month the change will not be too much, however, for those who owe a lot of money on their credit cards the change could be significant. During the last quarter of 2021, credit card debt in the United States grew by $52 billion, and the average American’s credit card debt is $5,525.
Auto loans will remain the same for those who have already bought a car, but will become more expensive for future buyers
Auto loans come with a fixed interest rate indexed to U.S. Treasury yields. This means that the cost of credit financing for new drivers will not get more expensive with a FED rate hike.
Unfortunately, the same is not the case for those just considering buying a car, as the interest rate for new loans is susceptible to change. The financing terms for vehicle purchase may vary depending on the dealer or bank where the loan is applied for. The average rate for a five-year car loan is 3.98% per year.
Student loans: All things being equal for now
For federal student loans, interest rates have already been fixed for the 2021-2022 school year, so an interest rate hike does not mean an immediate increase in the cost of student loan payments.
During the month of May, student loan interest rates will be based on the last 10-year Treasury note auction. These rates remain fixed for the entire duration of the loan.
Rates for federal student loans to attend college currently stands at 3.73% per year through June 2022. However, the Department of Education estimates that in the coming year the increase in interest rates could affect the loans that will be granted for the next academic year.
Private education loans, however, could be affected by the rise in rates. Private student loans either charge fixed rates, which remain constant, or variable rates, which can increase or decrease depending on the institution they borrow from or their particular financial circumstances.