January 2, 2019
Your Christmas gift from the Federal Reserve is here. Surprise! It’s another 0.25% hike in the Federal Funds rate. Sure, you’ve already gotten this same gift three other times in 2018, and nine times since late 2015 – but what else would you expect to receive from the Fed?
Interest rate hikes from the Fed really can be a positive gift to you, but it’s more likely to be a negative – depending on whether you’re a saver or a spender.
The Federal Funds rate is the benchmark rate used to transfer money between banks. This rate is generally passed on to consumers. Borrowers are charged higher interest rates on the money they borrow, while savers are eventually offered better interest rates on checking and savings accounts as well as certificates of deposit (CDs).
In some cases, the changes are passed on directly to consumers. For example, credit cards and adjustable-rate mortgages (ARMs) have rates tied directly to benchmark rates. The rate you pay will be some percentage rate factor plus the benchmark rate. When Fed rates goes up, your interest rates go up at the next adjustment period.
Credit cards tend to adjust upward within a billing cycle or two – check your credit cardholder terms and conditions for the exact adjustment period and rate factor. Home equity lines of credit (HELOCs) have similar adjustment periods.
ARMs are generally adjusted each year, so the impact may not be felt for some time – but it will be greater if several rate increases have occurred since the last adjustment.
Fixed-rate loans like auto loans and non-adjustable mortgages are affected indirectly. Rates will gradually change because it costs banks more to borrow money from each other to manage cash flow. Banks have to raise rates on fixed-rate offers moving forward to account for increased expenses.
If you already have a fixed-rate loan, you’re paying the already-agreed-upon rate – making fixed-rate loans the best choice when interest rates are predicted to rise. It doesn’t matter whether the benchmark rate is low or high when you take out your loan – it only matters whether rates rise or fall afterward.
Market forces will eventually increase interest rate offers on depositor accounts (savings, checking, etc.). As banks gain more latitude to offer better depositor rates, they will tend to attract more business. If you have a depositor account with them, banks will offer other tie-in deals on credit cards and other bundled deals to retain your business.
You can’t change the Fed’s rate increases, but you can react to them in a way that reduces financial pain.
Re-evaluate your credit cards to see if you’re getting the best deal possible based on your credit score. If you qualify, you may be able to take advantage of a balance transfer credit card that allows you to pay down debt during a 0% APR introductory period. Visa Credit Expert Sean McQuay advises, “If consumers want to lower their interest rate for cards they already have, the best option by far is this balance transfer where they basically are taking it from whatever the rate is today to zero.”
Keep your credit score as high as possible to get the lowest interest rate. Personal Finance Authors David Auten and John Schneider, aka “The Debt Free Guys,” explain: “Having a high credit score is important because it can literally save you thousands of dollars when you need to finance anything, whether it’s a home or a car, your education, anything you are financing is going to be based on your credit score. So, the percentage that you are going to pay in interest is based on that credit score. So, having a high credit score is going to reduce your interest, it’s going to make you less risky to the banks.” You can check your credit score and read your credit report for free within minutes by joining MoneyTips.
You could also choose to never charge more than you can pay off in the billing cycle. If you never carry a balance, interest rates don’t matter.
If you have an adjustable-rate loan, consider refinancing it into a fixed-rate loan. Generally, you’ll pay more upfront but less in the long term. Use the same analysis when considering new debt – are you sacrificing lower initial payments for potentially unmanageable payments in the future?
We hope you enjoy the Fed’s present, because there are two more planned for 2019. Sorry, no refunds or exchanges are allowed. You’ll just have to live with the financial gift that keeps on giving.
If you want more credit, check out our list of credit card offers.