Interest rates impact all levels of your financial life. The most popular interest rates are driven by the Federal Reserve’s monetary policy decisions. The Fed manages interest rate levels to meet their mandate of fostering “maximum employment and price stability.”
Yet most consumer interest rates are driven by the federal funds rate, which is also considered the central interest rate in U.S. financial markets. Simply put, the fed funds rate is the interest rate that major banks use when borrowing or lending funds through the nation’s central Federal Reserve banks. The fed funds rate is set by the Federal Open Market Committee — the policy-making arm of the Fed led by Federal Reserve Board chair.
The Federal Reserve Bank of St. Louis, one of the 12 member banks of the Federal Reserve system, breaks down the impact of the fed funds rate. This fundamental interest rate influences the prime rate — the rate given to bank’s customers with the highest credit ratings, mortgage and loan rates, as well as the yield on your savings accounts.
Here’s what you need to know to make smarter financial decisions today by understanding the direction of future interest rates.
Because the Fed funds rate ultimately influences many other market interest rates, a variety of interest rates exist, from the higher car note rate to the rock bottom return on your bank savings account.
Additionally, the Fed funds rate influences the prime rate, the interest rate awarded to bank customers with the best credit, which is tied to various loans and savings account yields. Today, the prime rate is 4.25 percent — the highest level of the year and 3 percent above the fed funds rate. You can estimate the prime rate by adding 3 percent to the fed funds rate.
Since January 2017, the Fed has raised rates three times, bringing the important interest rate to a range of 1.25 and 1.50 percent. The low 4.1-percent unemployment level and continuous growth of wages support this federal funds rate projection. But don’t expect rates to stop there: In her recent speech, current Federal Reserve Board chair Janet Yellen stated the Fed’s goal of reaching a 2-percent inflation target.
Looking forward, next year’s interest-rate forecast includes three quarter-point increases and two increases in both 2019 and 2020. Find out how these interest-rate boosts might affect your finances in 2018.
Gloomy Savings Rates Forecasts
Retirees and savers are tired of the low-interest rates and are looking forward to the Fed raising interest rates. Despite the modest rate increases this year, the average money market savings account rate remains a paltry 0.09 percent, according to the FDIC.
Fortunately, an interest rate hike should slightly increase savings account rates, according to a recent MarketWatch article. But don’t expect to make a fortune using a savings account as your only growth tool.
For the best rates, you might consider seeking out promotions at online banks, which have lower overhead and can offer higher rates than traditional banks. For example, if you invest $5,000 in a one-year CD at online Ally Bank, you can expect to receive 1.55% APY, which is far superior to the current national CD rate of 0.28 percent.
Changes to Some Student Loan Rates
For existing fixed-rate loans, such as a Federal student loan, your rate will remain the same as interest rates increase. But, that’s where the good news ends. Many private student loan interest rates are variable and will increase when the Federal Reserve raises rates.
The amount of the increase depends upon the underlying rate to which the loan is tied — Libor, prime or T- bill. For example, if the fed funds rate increases by 0.25 percent, you might see a variable rate increase by the same amount.
So if your loan interest rates are fixed, celebrate. Or if you have excessive student loan debt, particularly private loans with variable rates, you might consider applying for a debt consolidation loan to avoid future rate increases. Just be mindful that you don’t stretch out the loan term because you will likely end up paying much more interest.
Increase in Credit Card Rates
Most credit cards have variable interest rates, so when the Fed raises rates, your credit card issuer quickly follows suit. In December, average credit card rates are in the range of 15 to 16 percent. How much your credit card interest rate will rise depends on several factors, determined by the issuing company.
To minimize credit card interest payments, the solutions are simple. First, if possible, pay off your credit card in full. You’ll save interest charges by making a habit of paying the full amount of your card balances each month. Or for high balances you can’t pay all at once, consider a 0% intro APR balance transfer for short-term protection against a rate hike.
Future Mortgage Rate Changes
Fixed mortgage loan holders can rejoice as their interest rates will remain steady after a fed rate hike. Variable-rate mortgages and new mortgage loans will be affected by rising interest rates.
Kiplinger’s latest mortgage rate forecast projects that new 30-year, fixed-rate mortgages will rise to 4.40 percent, up from today’s 3.95 percent rate. The 15-year fixed rate is also expected to increase 0.40 percent from the current 3.30 to 3.70 percent rate.
For home equity lines of credit, which are pegged to the prime rate, the rate increases annually. In the short term, however, the upcoming rate hikes shouldn’t affect your payment until your HELOC reset date arrives.
Overall, the solution for the rising mortgage interest rates forecasts to consider refinancing your variable-rate loan to a fixed-rate solution without extending the loan term. You might even think about getting a 15-year fixed rate loan to decrease your total interest payments.
Auto Loan Rates Reset
By now you get the trend. New auto loan rates will rise, and current fixed-rate auto loans won’t be impacted by a boost in interest rates. Note that new auto loan rates are tied to the prime rate and could increase from 4.25 to 5.00 percent by the end of 2018.
As with all consumer debt, it’s a good idea to pay off your auto loan as quickly as possible. And check out end-of-year sales to beat next year’s rate hikes if you’re in the market for a new vehicle. When financing a new vehicle, cut your total interest rate by choosing a shorter-term loan over a longer one. Or, if you can afford it, buy a used car with cash.
What the Future Ultimately Holds for Interest Rates
Despite the low inflation and rising interest-rate predictions, we’re still in a historically low interest-rate environment. But, as historical charts illustrate, interest rates are volatile and can be unpredictable.
Borrowers, do what you can to keep your interest payments small and pay off consumer debt as quickly as possible. Savers, search for higher CD and money market returns. With rate increases continuing, you can look forward to growing returns on your savings and higher debt costs.