Trimming back on your credit line usage and shopping around to lock in a fixed-rate mortgage are a couple of ways to trim costs following the fed funds rate increase. (Getty Images)
In March, the Federal Reserve announced it would officially increase the fed funds rate from 1.5 percent to 1.75 percent. Credit card holders are going to want to pay close attention to this, because this rate hike can make it more expensive to leave a balance sitting on your credit card accounts. Here’s what you need to know.
The connection between the fed funds rate and your credit card bill. The federal funds rate is the interest rate banks charge each other to borrow money. It’s also a benchmark used to set interest rates on debt and savings products for consumers. When the fed funds rate goes up, interest rates on credit cards, mortgages, and other loans follow behind it.
Credit card debt is one area where consumers can get hit hard. Credit cards typically have a variable interest rate, so the cost of keeping a balance can soar as the fed funds rate trends upward. According to data from the Federal Reserve, the average interest rate for credit cards issued by commercial banks that were assessed rose from an annual percentage rate of 14.99 percent in November 2017 to 15.32 percent APR in February 2018.
In periods of economic growth when there’s job creation, the unemployment rate is down, and wages are increasing, the Federal Reserve may increase the fed funds rate to protect against inflation.
“If things go as expected, we should expect between three and four more [rate] hikes this year,” says Marco Di Maggio, professor of finance at Harvard Business School. Di Maggio says projections point to an overall rate increase of 1 percent over the course of 2018.
Using a credit card isn’t inherently bad, but keeping a revolving a credit card balance can get more expensive as rates rise. There are a few ways you can minimize how the fed funds rate increase affects your wallet.
“Stop charging and pay the balance in full every month,” says Greg Knight, a certified financial planner based in Oakland, California. “By paying your balance in full each month you will avoid paying higher interest charges when the credit card issuer raises your rate.”
Knight suggests meeting with an advisor if you have trouble paying off your bills. An advisor can run a debt analysis to help you come up with a strategy to attack your most expensive debt.
You might also consider consolidating your debt via a balance transfer or a personal loan. Either of these tactics could help stabilize your debt payments.
Unlike a variable interest credit card, personal loans with a fixed interest rate will remain fixed even as the Fed rate floats up. Shop personal loans at multiple lenders (ideally, starting with your local credit union first) in order to compare rates and ensure you’re getting the best deal.
If you find a balance transfer with a generous zero percent intro APR, you could buy yourself extra time to pay off the debt without worrying about interest piling up. Just keep in mind you’ll need decent credit to qualify for the best balance transfer card options.
What about your mortgage? Projected Fed rate hikes will likely impact first-time homebuyers and current homeowners who have adjustable rate mortgages the most, Di Maggio says. Even a slight change in rates can have a big impact on a new purchase or adjustable-rate mortgage because a mortgage has such a large balance. The average rate for a 30-year fixed-rate mortgage rose from 3.95 percent on Jan. 4 to 4.40 percent as of April 5. That might sound like a small change, but it can easily add tens of thousands of dollars to the cost of a mortgage over a 30-year period.
“Homebuyers that are shopping for a new home should already be working with a mortgage lender,” Knight says. If you’re ready to lock in a rate, consider doing it sooner rather than later.
As for homeowners with adjustable-rate mortgages, Knight says now would be a good time to comparison shop and lock in to a fixed-rate mortgage ahead of the rate hikes projected by early 2019.
Last but not least, don’t forget about homeowners who have outstanding home equity lines of credit or home equity loans. This form of debt typically has a variable interest rate and may see a price bump as well. Think about putting a dent in your home equity loan to minimize interest costs.
The silver lining: Your savings rate may rise. There are two sides to this story. The Fed rate hike impacts how much you pay to borrow money and how much you earn in interest through various bank products like savings accounts and CDs. With that said, increases to savings rates may be small in comparison to the increases you’ll see for mortgages and other debt products, especially if you do business with brick-and-mortar banks.
“Banks adjust the interest rate at which we can borrow almost immediately as the Fed increases the [funds rate],” Di Maggio says. “You don’t see the same translation in the savings vehicles. The bank passes through all of the costs but not really all of the benefits.”
There is, however, some opportunity in online savings accounts. Online savings accounts tend to blow brick-and-mortar banks out of the water when it comes to interest on products. You may want to think about taking your savings online to earn more.
The bottom line. The announcement of the fed funds rate hike is one that can hit your wallet in many ways. Being aware of its implications can help you lessen the cost. Cutting back on credit line usage can save you a bundle on interest charges. And comparison shopping for mortgages, auto loans and other debt vehicles in advance may help you lock in rates before they soar.