The Federal Reserve is turning to its most potent weapon to combat the highest inflation in 40 years: Boosting interest rates. On Wednesday, the central bank said it is increasing its benchmark short-term interest rate by 0.5%, marking the largest increase since 2000.
The Fed’s goal is to tamp down demand from consumers and businesses for goods and services. By boosting rates, the thinking goes, it will become more expensive to borrow money to buy a home, car or other needs, prompting some people to hold off on purchases. A drop in demand could help tame inflation, which accelerated to 8.5% in March, the highest increase since 1981.
The move shouldn’t come as a complete shock to consumers and businesses, given that the Fed already boosted rates by a quarter point in March and signaled that more hikes would be coming. At the same time, Americans have become used to low interest rates for everything from home-buying to auto loans. A half-point hike, or 0.50%, could translate into higher costs that could take a bite out of your budget.
“For the first time in 22 years, the Federal Reserve is poised to raise interest rates by more than a one-quarter percentage point increment,” said Greg McBride, chief financial analyst at Bankrate, in an email prior to the Fed announcement. “This hints at the steps households should be taking to stabilize their finances — pay down debt, especially costly credit card and other variable rate debt, and boost emergency savings.”
To be sure, even with the biggest interest rate hike since 2000 — when the U.S. was in the midst of the dot-com bubble — rates remain historically low. With the boost, the federal funds rate will likely sit at 1%, compared with 6.5% when the central bank last raise rates by the same amount in 2000, according to data compiled by Bankrate.
Here’s what the increase will mean for your wallet.
What will the rate hike cost you?
Every 0.25% increase equates to an extra $25 a year in interest for $10,000 in debt. So a 50 basis point increase will translate into an extra $50 of interest for every $10,000 in debt.
However, economists don’t expect the Fed to stop raising rates after Wednesday’s announcement. Economists are forecasting the Federal Reserve will direct another 50 basis point increase in June, with additional increases to follow later in 2022.
By year-end, the federal funds rate could reach 2% or higher, according to LendingTree Senior Economic Analyst Jacob Channel. That implies a rate increase of about 1.5% from current levels, which means consumers could pay $150 in additional interest for every $10,000 in debt.
Credit cards, home equity lines of credit
Many consumers will feel the pinch via their credit cards, according to LendingTree credit expert Matt Schulz.
“Your credit card debt is going to get more expensive in a hurry, and it’s not going to stop anytime soon,” Schulz said in an email.
Expect to see higher APRs in a billing cycle or two after the Fed’s announcement, he added. After the Fed’s March hike, interest rates for credit cards increased across 75% of the 200 cards that Schulz reviews every month, he said.
“Most Americans’ financial margin for error is small, and when gas, groceries and seemingly everything else gets more expensive and interest rates go up, too, it makes it much harder,” he wrote. “Now is the time for those with credit card debt to focus on knocking it down.”
For instance, consider a 0% balance transfer credit card or a low-interest personal loan. Consumers can also call their credit card companies and ask for a lower rate, which is frequently a successful approach, he added.
Other types of credit with adjustable rates may also see an impact, such as home equity lines of credit and adjustable-rate mortgages, which are based on the prime rate. Auto loans may also rise, although these can be more sensitive to competition for buyers, which could dampen the Fed hike’s impact.
Will mortgage rates continue to rise?
Homebuyers have already been walloped by surging mortgage rates, which have jumped about two percentage points in one year, topping 5%.
That’s adding thousands to the annual cost of buying a home. For instance, a purchaser buying a $250,000 home with a 30-year fixed loan at last week’s average rate of 5.3% will pay $3,300 a year more compared to what they would have paid with the same mortgage in April 2021, according to figures from the National Association of Realtors.
But the Fed’s rate hike might not translate into an immediate increase for mortgage rates, LendingTree’s Channel said.
“In fact, this latest rate hike could already be baked into mortgage rates which are currently sitting at an average 5.10% for a 30-year, fixed rate mortgage,” he noted. “With that said, rates have risen very dramatically this year, and they could go even higher.”
Savings accounts, CDs
If there’s an upside for consumers, it’s that savings accounts and certificates of deposit could provide higher yields.
“Rate increases are likely to accelerate after the highly anticipated May Fed rate hike,” said Ken Tumin of DepositAccounts.com in an email.
In April, the average yields of accounts from online banks increased 4 basis points to 0.54% for savings accounts, while 5-year CDs rose 47 basis points to 1.7%.
While that’s a better yield for savers, it’s nevertheless problematic in a high inflation period. Even with those higher rates, savers are essentially eroding the value of their money by socking it into a savings account while inflation is running above 8%.