Fed rate hikes are coming — how to tackle your savings, mortgage, car payments and credit-card debt in advance
Wall Street investors and Washington D.C. lawmakers are closely listening to what Federal Reserve Chairman Jerome Powell says Wednesday about the central bank’s next steps in its fight against decades-high inflation.
“In light of the remarkable progress we’ve seen in the labor market and inflation that is well above our 2% longer run goal, the economy no longer needs sustained high levels of monetary-policy support,” Powell said.
“I would say that the committee is of a mind to raise the federal funds rate at the March meeting, assuming that conditions are appropriate for doing so,” he added.
About that volatility: Investors are, among other things, rattled by an expected increase for the critically influential federal funds rate is widely anticipated to happen in March, ushering in a series of potential rate hikes through 2022.
When Federal Open Market Committee (FOMC) increases rates, borrowing costs increase throughout the economy — and come back to haunt consumers who need to factor those higher borrowing costs in their financial decisions.
“As Jerome Powell charts a course for rate hikes, Americans will need to plan the next steps for their finances in the coming months.”
“With inflation well above 2% and a strong labor market, the FOMC expects it will soon be appropriate to raise the target range for the federal funds rate,” the Fed said in its policy statement released Wednesday afternoon.
It did not commit to a rate hike at its meeting scheduled for mid-March.
The federal funds rate is the interest rate that banks charge each other for short, overnight loans and use as a baseline for other lending rates. The rate is now essentially 0%, a basement level that was initially meant to aid the economy in the pandemic’s earlier phase of lockdowns and sky-high unemployment rates.
The Fed has good reason to mull a rate hike: Jobless rates are far lower, lockdowns are gone and price inflation gnaws household budgets. The pace of inflation in December hit 7%, a nearly 40-year high.
As Powell charts a course for rate hikes during this recovering economy, here’s how people can plan their own next financial steps for the coming months:
What to do if you’re buying a house
Anyone who’s been in the market for a mortgage — either to buy a home or to refinance their loan — has no doubt born witness to the stunning rise in interest rates for these products.
As of Thursday, mortgage rates were at a pandemic-era high, with the benchmark rate for the 30-year fixed-rate mortgage averaging 3.56%. In the span of four weeks, the rate on the 30-year loan has risen more than 50 basis points, or half a percent.
Here’s the good news: The Fed’s upcoming rate hike has already been baked into mortgage rates — the Fed manipulates short-term interest rates, while mortgage rates are long term. Consequently, expectations of the Fed’s actions are already being factored into the rates lenders offer applicants.
Plus, the Federal Reserve has reduced the amount of mortgage-backed securities it is purchasing, while has reduced liquidity in the mortgage market. That, too, may be having an effect on interest rates.
“In the span of four weeks, the rate on the 30-year loan has risen to 3.56%, or more than 50 basis points.”
Another positive: It’s getting easier to qualify for a mortgage in one sense. As rates rise, refinance volumes dwindle. It’s easier for lenders to attract refinancing customer, but they have to compete more for home buyers.
“Lenders are thirsty for volume as refinancing traffic wanes and the investors that buy mortgage debt are still very much in a ‘risk-on’ mode,” Greg McBride, chief financial analyst at Bankrate, told MarketWatch in December. “Until either of those changes, there isn’t an obvious catalyst for a tightening of mortgage credit.”
At the same time, higher rates could make it harder for some buyers to qualify, since it’s a more onerous financial commitment.
Economists expect that the rise in mortgage rates in recent weeks has already triggered an unseasonable rush to purchase homes well ahead of the typical peak spring home-buying season. These buyers are aiming to lock in cheap financing while they still can. Real-estate experts believe that mortgage rates will continue to rise throughout the year.
Any home buyer looking to join that rush should be mindful of their timing. Mortgage pre-approvals typically last for 90 days, but some lenders offer shorter windows, according to Bankrate. Mortgage rate locks, meanwhile, are generally good for 15 to 60 days, according to Rocket Mortgage.
In both cases, you can typically ask your lender for an extension, though sometimes that will involve another credit check or an additional fee.
The spring home-buying season is just around the corner, and that will be a time when more properties will come to market. Nevertheless, today’s buyers should be prepared for a tough market. The inventory of homes for sale hovers around record lows, meaning the properties that are on the market will likely fetch multiple offers and attract bidding wars.
Chances are many buyers won’t succeed on their first bid, so it’s important to keep that in mind when seeking pre-approval. If a family isn’t ready to close a deal quickly, they may be shooting themselves in the foot by getting pre-approved prematurely.
What about your credit-card balance?
Some blunt advice: Pay off as much as possible before rate hikes push up credit card’s APR (annual percentage rate), experts say.
Lenders come up with their APRs by factoring in the so-called “prime rate” — which is closely tied to the Fed’s rate — with other components like credit scores and a person’s risk of defaulting.
When the Fed’s rate goes up, APRs closely follow and the cost of carrying a balance goes up, Matt Schulz, LendingTree’s chief credit analyst, previously said. After a rate increase, it can take up to two months for APRs to increase, he said. The average APR is now 19.55%, unchanged from December, according to LendingTree.
“If you have a credit card and you are carrying a balance month to month, interest rates should be of some importance to you,” said Bruce McClary, spokesman for the National Foundation for Credit Counseling.
“‘If you have a credit card and you are carrying month to month, interest rates should be of some importance to you.’”
— Bruce McClary, spokesman for the National Foundation for Credit Counseling
That’s a large number of people, because 38% of consumers are carrying some sort of credit-card debt month to month, according to the organization’s recent survey. That’s down from 43% in 2020.
However, McClary noted roughly 30% are spending more than a year ago and approximately one-fifth say they are saving less. “A lot of people are living close to the edge” and even a small APR increase may have an outsized impact, he said.
When paying off a balance is not possible, McClary said there are other things people can do. One idea is looking now for a new credit card where people can make a balance transfer for a lower rate and fees. APRs on 0% balance-transfer cards now stand at 18.09%, LendingTree date showed.
Another often overlooked idea is negotiating with the credit-card lender to get a lower APR, or find another card from the issuer that offers lower rates, McClary said.
These strategies are best for people with good credit scores, McClary noted. But the scores for many people have climbed during the pandemic and they might not even realize it, he said.
Should I get a car loan before the rate hike?
To begin with, cars aren’t much of a bargain these days — thanks to the ongoing chip shortage which is limiting supply of both new and used cars.
Over the past year, prices for used cars and trucks have jumped by 37%. While prices for new vehicles increased nearly 12% over the past year, according to the December Consumer Price Index.
If you’re looking to take out an auto loan to finance your new car, you don’t need to rush to seal the deal to save money before the Fed’s rate hike goes into effect, said McBride at Bankrate.com.
“‘The difference of one-quarter percentage point amounts to a difference of $3 per month for a car buyer borrowing $25,000.’”
— Greg McBride, chief financial analyst at Bankrate.com
“A rise in interest rates has a minimal impact on auto loan rate affordability,” he told MarketWatch. “The difference of one-quarter percentage point amounts to a difference of $3 per month for a car buyer borrowing $25,000.”
The interest rate on your car payment is more sensitive to factors such as your credit score, credit history, and debt-to-income ratio “than a marginal increase in the federal funds rate,” said Shannon Bradley, an auto loans expert at NerdWallet NRDS, +3.44%.
If you put off purchasing a car right now, you’re probably going to pay a higher interest rate on an auto loan but you “may also be in a position to buy at a better price,” Bradley said. But that depends on whether the supply of cars recovers, or not.
Where can I safely put my savings to work?
Savings accounts and certificates of deposit are not the place to make eye-popping returns on investment, but they can be a conservative way to bring in a little bit extra while still maintaining a rainy day fund.
Because the annual percentage yields (APY) for these accounts closely hinge on the Fed rate, upcoming rate hikes will make those returns slightly more generous, said Ken Tumin, founder and editor of DepositAccounts.com.
That’s especially true for the savings accounts and CDs offered by online banks instead of legacy, brick and mortar banks,Tumin said.
For example, the average savings account rate for all banks is 0.06% in January, but for online banks, the average rate is 0.46%, Tumin said. Brick and mortar banks are “flush with deposits,” so they have less incentive to quickly bump up rates in a race for accounts, Tumin said.
It could take years and multiple rate hikes for brick and mortar banks to increase the average rate to 0.09%, Tumin said. But if history is any guide, the rates at online banks will closely match the federal funds rate, and at a much quicker pace.
In December 2018, the target rate for the federal funds rate was 2.25%-2.25%, he noted. At that time, online savings accounts offered an average 2.23% APY, he said. It was an average 2.72% for a one-year CD from an online bank, he said.
The rates for CDs have been rising and Tumin says the upward trend will continue. The APY on all one-year CDs is now 0.13% and it’s 0.51% for online banks.
Keep in mind CDs have lockup periods and penalties on early withdrawals. When it comes to financial strategies in the current environment, CDs are “not replacing stocks and bonds,” Tumin said. “I see it supplementing a savings account.”
In the meantime, Powell said there’s a long way for the pandemic-era recovery to go. “The economic outlook remains highly uncertain,” he said Wednesday. “Making appropriate monetary policy in this environment requires humility, recognizing [that] the economy evolves in unexpected ways.”