Federal Reserve Chairman Jerome Powell telegraphs his first blow to the fight against inflation – his intention to support a 25 basis point hike in the benchmark interest rate, the first of a string of potential rate hikes this year.
Now it’s time for consumers to make their own maneuvers, especially for those planning to pay off credit card debt or build up their savings in 2022.
On its own, experts say a quarter percentage point increase won’t make much difference to their credit card annual interest rate (APR) or their savings account’s annual percentage yield (APY). But add together a few tariff increases and consumers start to feel out of place, they say.
Speaking before Congress on Wednesday and Thursday, Powell spoke about what he’s considering at a major policy meeting scheduled for mid-March. That way, markets won’t have to wait in trouble when there’s already so much uncertainty – due to Russia’s invasion of Ukraine – and they won’t be hit when the federal funds rate rises, which is now close to zero.
“I think it would be appropriate to raise our target range for the federal funds rate at the March meeting in a couple of weeks. And I am inclined to propose and support a 25 basis point rate hike,” he told lawmakers on Wednesday.
On Thursday, he reaffirmed plans for a 25 basis point hike and said he was supporting a “series” of hikes in 2022. If price inflation remains high, Powell said, the Fed will be ready to raise rates by more than a quarter of a percentage point.
The markets liked the certainty, and it’s good for consumers because the federal funds rate has a big impact on the credit card annual interest rate and the savings account annual interest rate. Here’s more about those relationships:
Additional credit card charges
If the rate hike happens this month, it could be April or May when credit card holders see the higher annual interest rate hit their bills, said Matt Schultz, chief credit analyst at LendingTree. For those with credit card debt, “any rate hike is undesirable, but the truth is that the Fed’s March action is unlikely to shock most people’s financial world if it’s only a quarter-point increase. The danger arises if the rate increases – and in large portions.
Consider this scenario:
The person has a balance of $5,000 and pays $250 monthly with an annual interest rate of 16.44% (average credit card interest rate in the fourth quarter of 2021, according to the Fed). To pay off the balance, the individual will pay $884 in interest, Schultz said.
Comes an increase of 25 basis points:
That would translate into a potential 16.69% per annum as the base rate that issuers use to determine their credit card rates historically eats up the full amount of federal funds rate hikes, Schultz said. Now the same person is paying $900 in interest to pay off the balance, up $16 over the life of the loan, he said.
And another 25 basis point increase:
At an annual interest rate of 16.94%, this translates into $917 in interest, which is an additional $32 over the life of the loan.
If there are six quarter-percentage rate hikes — which isn’t unbelievable when some observers say there could be seven — that translates into a 1.5% annual interest rate hike, Schultz said. The borrower now has to pay $985 in interest, he said. This is an additional $101 over the life of the loan.
In times of high inflation, an extra $101 paid in interest instead of food or gas will be a hard reality for families living paycheck to paycheck. The median hourly wage was unchanged from January to February but rose 5.1% year on year, according to Friday’s employment report.
Americans had an estimated $860 billion in credit card debt in the fourth quarter of 2021, according to the Federal Reserve Bank of New York. Borrowers had an average of $4,857 in credit card debt in the third quarter, according to TransUnion TRU, +2.13%, one of the three big credit bureaus.
It is worth noting that some rates will be higher depending on the credit history of the cardholder. In February, the average rate across all new card offerings was 19.53%, according to LendingTree.
Higher Savings Account Returns
“The good news about raising interest rates is that consumers who put their money into high-yielding savings accounts will grow faster, so continuing to save this year will bring more returns than last year,” said Gannesh Bharadwaj, CEO director. credit cards in Credit Karma INTU, -1.64%.
Savings accounts are a place to safely store easy-to-reach cash, not to generate large incomes. According to Ken Tumin, founder and editor of DepositAccounts.com, the additional interest income after the rate hike will be modest at first, but can add up depending on how many times the rate hike occurs.
Right now, an online savings account is averaging 0.49% per annum, he said. According to Tumin, historically, not all rate hikes were carried over to APY, at least at first.
He estimates that a 25 basis point increase could mean a potential average annual return of around 0.55-0.6%. If there is $10,000 in the savings account, this small step forward brings in an additional $10, Tumin says.
But we are talking about a multiple increase in rates. If there were six quarter percentage point increases, he estimated, the same $10,000 bill could bring in an additional $100 a year.
Online savings accounts are the place to find elevated APYs, not “regular” banks, Tumin said.
During the previous rate hike cycle from 2015 to 2018, there were three quarter-point increases “before the average APY high-yield savings account received any significant gains,” he noted. “This time around, growth could be faster as rates on high-yield savings accounts have fallen to levels well below their pre-2015 lows.”
“Insignificant Impact” on Mortgage Rates
“For housing, the Fed’s short-term rate has little effect on mortgage rates,” said George Ratiu, senior economist and economic research manager at Realtor.com.
According to him, another action by the FRS is connected with these rates. Along with cutting the federal funds rate in the early days of the pandemic, the central bank also bought up Treasury debt and mortgage-backed agency securities. The central bank decided it was time to put an end to this.
From 2020 to 2021, these Fed purchases injected liquidity and lowered mortgage rates, Ratiu said. “As the Fed announced it plans to complete its cuts [mortgage-backed securities] purchases later this month, we are seeing rates rise to highs not seen since mid-2019.”
So potential homeowners are already paying for the Fed’s actions. The average fixed rate on 30-year mortgages reached 3.76% this week, according to Freddie Mac FMCC, -1.41%. By comparison, a year ago, the 30-year fixed mortgage rate was closer to 2.7%.
One basis point is equal to one hundredth of a percentage point. This is a major shift from just a few weeks earlier, when the average 30-year loan rate jumped to its highest level since May 2019, close to 4%.
According to Realtor.com, the median February listing was $392,000. Ratiu noted that compared to last year, the buyer will pay $278 more for a monthly mortgage. That’s more than $3,300 added to the buyer’s yearly financial burden.
“An additional increase in mortgage rates will further shrink buyers’ budgets and could limit the ability of new buyers to qualify for a mortgage, especially as prices continue to rise,” he said.