WASHINGTON – 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 embarks on what's likely to be a prolonged period of rate hikes to fight inflation.
Record-low mortgage rates below 3%, reached last year, are already gone. Credit card interest rates and the costs of an auto loan will also likely move up. Savers may receive somewhat better returns, depending on their bank, while returns on long-term bond funds will likely suffer.
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The Fed's initial quarter-point rate hike Wednesday in its benchmark short-term rate won't have much immediate impact on most Americans' finances. But with inflation raging at four-decade highs, economists and investors expect the central bank to enact the fastest pace of rate hikes since 2005. That would mean higher borrowing rates well into the future.
On Wednesday, the Fed's policymakers collectively signaled that they expect to boost their key rate up to seven times this year, raising its benchmark rate to between 1.75% and 2% by year's end. The officials expect four additional hikes in 2023, which would leave their benchmark rate near 3%.
Chair Jerome Powell hopes that by making borrowing gradually more expensive, the Fed will succeed in cooling demand for homes, cars and other goods and services, thereby slowing inflation.
Yet the risks are high. With inflation likely to stay elevated, in part because of Russia's invasion of Ukraine, the Fed may have to drive borrowing costs even higher than it now expects. Doing so potentially could tip the U.S. economy into recession.
“The impact of a single quarter-point interest rate hike is inconsequential on the household budget,” said Greg McBride, chief financial analyst for Bankrate.com. “But there is a cumulative effect that can be quite significant, both on the household budget as well as the broader economy.”
Here are some questions and answers about what the rate hikes could mean for consumers and businesses:
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I’M CONSIDERING BUYING A HOUSE. WILL MORTGAGE RATES GO STEADILY HIGHER?
They already have in the past few months, partly in anticipation of the Fed's moves, and will probably keep doing so.
Still, mortgage rates don’t necessarily rise in tandem with the Fed’s rate increases. Sometimes, they even move in the opposite direction. Long-term mortgages tend to track the rate on the 10-year Treasury note, which, in turn, is influenced by a variety of factors. These include investors’ expectations for future inflation and global demand for U.S. Treasurys.
Global turmoil, like Russia's invasion, often spurs a “flight to safety" response among investors around the world: Many rush to buy Treasurys, which are regarded as the world's safest asset. Higher demand for the 10-year Treasury would lower its yield, which would then reduce mortgage rates.
For now, though, faster inflation and strong U.S. economic growth are sending the 10-year Treasury rate up. The average rate on a 30-year mortgage, in turn, has jumped almost a full percentage point since late December to 3.85%, according to mortgage buyer Freddie Mac.
HOW WILL THAT AFFECT THE HOUSING MARKET?
If you're looking to buy a home and are frustrated by the lack of available houses, which has led to bidding wars and eye-watering prices, that's unlikely to change anytime soon.
Economists say that higher mortgage rates will discourage some would-be purchasers. And average home prices, which have been soaring at about a 20% annual rate, could at least rise at a slower pace.
But Odeta Kushi, deputy chief economist at First American Financial Corporation, notes that there is such strong demand for homes, as the large millennial generation enters its prime home-buying years, that the housing market won't cool by much. Supply hasn't kept up. Many builders are struggling with shortages of parts and labor.
“We'll still have a pretty robust housing market his year,” Kushi said.
WHAT ABOUT OTHER KINDS OF LOANS?
For users of credit cards, home equity lines of credit and other variable-interest debt, rates would rise by roughly the same amount as the Fed hike, usually within one or two billing cycles. That’s because those rates are based in part on banks’ prime rate, which moves in tandem with the Fed.
Those who don’t qualify for low-rate credit cards might be stuck paying higher interest on their balances, and the rates on their cards would rise as the prime rate does.
Should the Fed decide to raise rates 10 times or more over the next two years — a realistic possibility — that would significantly boost interest payments.
The Fed’s rate hikes won’t necessarily raise auto loan rates as much. Car loans tend to be more sensitive to competition, which can slow the rate of increases.
WILL I BE ABLE TO EARN MORE ON MY SAVINGS?
Probably, though not likely by very much. And it depends on where your savings, if you have any, are parked.
Savings, certificates of deposit and money market accounts don’t typically track the Fed’s changes. Instead, banks tend to capitalize on a higher-rate environment to try to thicken their profits. They do so by imposing higher rates on borrowers, without necessarily offering any juicer rates to savers.
This is particularly true for large banks now. They've been flooded with savings as a result of government financial aid and reduced spending by many wealthier Americans during the pandemic. They won't need to raise savings rates to attract more deposits or CD buyers.
But online banks and others with high-yield savings accounts will likely be an exception. These accounts are known for aggressively competing for depositors. The only catch is that they typically require significant deposits.
If you're invested in mutual funds or exchange-traded funds that hold long-term bonds, they will become a riskier investment. Typically, existing long-term bonds lose value as newer bonds are issued at higher yields.