Earlier this month, Federal Reserve Chair Janet Yellen and other officials dropped some serious hints that they would be raising interest rates at this week’s meeting of the Federal Open Market Committee. So the Fed's recent announcement that it is raising the federal funds rate by a quarter percentage point, to between 0.75% and 1%, comes as no surprise.
If you’re feeling a bit of déjà vu, it’s because the Fed just raised rates back in December. That particular move was closely watched because the country’s central bank had been keeping interest rates at record lows in an effort to nurse the economy back to health from the recession. In fact, the December rate hike was only the second time the Fed had raised rates in a decade.
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The March increase, however, is significant in its own right because it signals that the Fed is bullish on the economy based on encouraging figures for job growth and inflation, among other economic indicators. Plus, it shows the Fed believes the country can now handle more frequent rate hikes — Yellen said that two more rate increases are still on the table for 2017.
All this chatter may make you nervous about the interest rates you pay now, considering many lenders use the federal funds rate as a benchmark to determine how much they’ll charge consumers to borrow money. But a rate hike may not have as negative of an impact as you think. Here are a few reasons why.
For your existing loans, only those with variable rates would be affected.
This means if you have loans or lines of credit with locked-in interest rates, like a fixed-rate mortgage or fixed-rate auto financing, you shouldn’t experience a change in what you’re paying. Remember also that federal student loan rates are fixed based on an interest rate Congress set at the time you borrowed the money.
“Many private student loans, however, are variable,” says Matt Shapiro, CFP®, a financial planner with LearnVest Planning Services. So if you have a private student loan it’s worth checking to see if your loan has a variable rate — and if so, when it’s scheduled to reset. “Those may experience a slight increase the next time they adjust,” he adds.
Even if interest rates do creep up on any of your variable loans, the impact on your monthly payment may not be as drastic as you’re expecting. For example, a quarter percentage point increase in the interest rate on a $25,000 loan being paid back over five years will result in a payment that's about $3 more each month, Shapiro says.
But of course, the bigger the loan, the greater the impact. That’s why it’s important for those who have an adjustable-rate mortgage to keep tabs on when their interest rates are due to change so they can prep their budget well in advance or figure out if it’s worth it to refinance.
One thing that helps with planning is that mortgage rates tend to move on just the anticipation of rate hikes, so you may have noticed them already going up. “But these rates are still near historic lows,” Shapiro adds.
Credit card APRs are more likely to be impacted by your credit score.
We all know the damage that high annual percentage rates can do if you keep a running balance on your plastic. So the thought of paying even more compound interest than you do now is probably enough to make your head spin.
But here’s the rub: Your credit score might actually be the bigger cause of that headache than a Fed rate hike. That’s because credit card companies heavily weigh your credit score when trying to decide what types of lending terms to offer you, whether that’s special deals, rewards or your APR.
Case in point: According to data from Credit Karma, credit card users with an excellent credit score (720 or higher) had an average APR of just under 14.3% in February; those with lower scores but still considered in the good range had an average APR of more than 17.5%. “[That’s why] it's better to make sure your credit is in order rather than worrying about small interest rate fluctuations,” Shapiro says.
You could see better interest rates on savings vehicles.
A rate hike isn’t all about paying more. When the Fed raises interest rates, that can include raising them for the things that pay out interest, too. As a result, you may see a tiny boost to the interest you could earn in savings accounts, money market accounts or certificates of deposit, says Shapiro.
That said, interest rates for these types of accounts are still really low, and banks aren’t likely to be in a rush to pass better yields onto customers (it might take a few additional Fed rate hikes for that to happen). So if you’re looking to increase your interest sooner rather than later, “you’re probably going to get a much better rate by going to an online savings bank,” suggests Shapiro. Because online banks have lower overhead than traditional banks, they tend to pass those cost savings along to customers in the form of more competitive interest rates.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.