Interest rates impact all levels of our financial lives. As anyone with a bank account and a car note recognizes, there’s more than one interest rate. In fact, 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 federal funds rate is the interest rate that major banks use when borrowing or lending funds through our 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 Janet Yellen.
The St. Louis Federal Reserve, 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.
2016 Interest Rates and Rates From the Federal Reserve
Since 2008, interest rates have remained uncharacteristically low, below 1 percent. The low interest rates deviate from the traditionally higher fed funds rate, ranging from a high of 16.39 percent in 1981 to a low of 3.02 percent in 1993. Recent fed funds rates have influenced low consumer interest rates ranging from average 48-month auto loan rates of 4.25 percent, minimal 15-year fixed rates and 30-year mortgage rates, along with CD rates below 1 percent.
At the Nov. 2 FOMC meeting, the committee had guardedly suggested a strong possibility of an interest rate increase. The committee’s November statement noted that businesses had failed to spend much and although inflation was up a bit, it was still below the FOMC’s 2-percent target. Thus, the FOMC had decided to wait for evidence of continued progress before making the decision to raise the fed funds rate.
The inflation rate continues to increase but hasn’t hit the FOMC target, so the interest rate hike announced Dec. 14, 2016 is small: The Committee raised the target range for the federal funds rate to 0.5 to 0.75 percent.
2017 Interest Rate Forecast
Interest rates for the coming year will be impacted by the FOMC decisions that were made at the December 2016 meeting. Since September, the labor market has strengthened and economic activity has been improving. The unemployment rate holds steady, and job growth continues as household spending slowly improves. The fed’s raising of interest rates has been expected by the markets and many economists.
The announced rate hike to 0.5 to 0.75 met economist Stavros Georgiadis’ expectation; he predicts the federal funds rate to be in the region of 0.75 percent to 1 percent during the first half of 2017. Georgiadis expects the fed to remain cautious in accordance with their desire to walk the path between economic growth and inflation. Judging by the financial markets, economist Garrett Baldwin assumes that the fed will raise interest rates again at its June meeting,. Baldwin’s expectation matches the economic projections released by the central bank showing an expectation that the Fed will increase rates three times in 2017.
Read on to find out how the December increase in the fed funds rate will impact 2017 interest rates.
How Will Consumers Be Impacted by Interest Rate Projections?
For retirees and savers looking for a decent return on their cash, interest payments have remained below zero, since 2010. These low rates are painful for consumers seeking a reasonable return on their emergency funds and cash investments. Will 2017 bring relief?
Any increase in the fed funds rate will ultimately help savers — but savers shouldn’t get their hopes up too high. Going back to 2004, when the federal funds rate was 1.35 percent, the three-month Treasury note, a proxy for cash returns, was 1.23 percent. So, even with a 0.5-percent increase in the fed funds rate, don’t expect to get rich on your savings account interest.
Baldwin’s interest rate projections for savers is cautious. He said that deposit rates might increase in 2017, and suggests that those looking for a better interest rate investigate online CD and savings accounts that pay north of 1 percent.
Mortgage Rate and Auto Loan Rate Predictions
The housing industry has been on a tear as mortgage interest rates have remained in the range of 3 to under 5 percent since 2010. Does a rate increase mean the end of rock-bottom interest rates for homebuyers?
Baldwin’s mortgage interest rates forecast suggests that a rise in the fed funds rate will increase the borrowing costs for the consumer. Mortgage rates have already pushed to their highest levels since July 2015. At an average 4.125 percent for a 30-year mortgage, the Nov. 20, 2016 rate was roughly a half percentage higher than it was on Election Day. In fact, it doesn’t take much of a rate increase to influence consumer borrowing rates. In 2008, the fed funds rate was 1.92 percent and the average 30-year home mortgage rate was 6.05 percent.
Even a small interest-rate hike on a large loan balance can cause a significant increase in monthly debt payments. In 2014, the average 30-year fixed mortgage loan rate was 4.17 percent. In 2015, the average dropped to 3.85 percent, and by June 2016 the rate fell to 3.57 percent.
The monthly principal and interest payment for a $225,000 mortgage at each of these rates is:
- 4.17 percent average rate in 2014: $1,096
- 3.85 percent average rate in 2015: $1,055
- 3.57 percent rate in June 2016: $1,019
If you estimate that in 2017, the mortgage rates trend creeps up to 5 percent, it would cost $1,208 per month or $2,268 per year more than if rates remained at the 2016 level of 3.57 percent. Multiply that $2,268 over 30 years and the higher interest rate could cost you an additional $68,040 over the life of the loan.
With an interest rate hike appearing likely, now’s a good time to refinance — or buy, if you’re in the market.
The same premise applies to auto loans. As a rule of thumb, to qualify for the best loan rate, pay your bills on time, use credit wisely, maintain good credit and a high credit score.
How Short-Term Interest Rates Will Impact Credit Cards
From 2014 to August 2016, the average credit card interest rates ranged from 13.19 to 13.76 percent. As recently as 2010, average credit card interest rates were 14.26 percent.
Despite a forecast of mild interest rate increases and a cautious economic outlook, it’s wise to follow sound money management principles. This is especially true when it comes to credit cards, which generally charge high interest rates. Of all the lending rates, credit card rates tend to be among the highest. So, attempt to pay off credit card balances as quickly as possible. And understand that to qualify for the best credit card rates, it’s important to maintain a high credit score.
Adjust Your Financial Strategy as Interest Rates Increase
Although no one knows where interest rates will land in the future, the current low rates are unlikely to continue indefinitely. “The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run,” the Federal Reserve said in a Dec. 14 press release.
Whether you’re considering investing in a 10-year treasury note, CD or other savings vehicle, you’ll benefit from the increase in the Fed Funds rate. Savers must look to maximize the returns on their cash by scouring the internet for the best savings rates. Just make sure that the online bank or credit union is insured with the FDIC or NCUA.
Borrowers should keep their credit profiles strong. If you have credit issues, take steps to improve your credit score to receive the best borrowing rates in the future. And if you’re in the market for credit, act sooner rather than later.