The Federal Reserve's decision to raise its key interest rate by a quarter of a percentage point for the fourth time this year will add to the costs of credit cards, home mortgages, and car loans. However, most consumers won't feel the impact of these rate increases until the next couple of months.
The Fed is trying to slow the economy and prevent it from experiencing the worst inflation in two decades. It's also raising interest rates to try and avoid asset bubbles from forming.
These actions have ended the era of ultra-low interest rates, created during the Great Recession to help the economy. They re-emerged during the pandemic. The central bank's benchmark rate was then reduced to near zero.
Federal Reserve Chairman Jerome Powell believes that by raising interest rates, the central bank can reduce the demand for various consumer goods and services. This could lead to a reduction in spending and bring inflation back to its target of 2%.
Despite the positive effects of the Fed's actions, the risks that it could cause the U.S. economy to go into recession are still high. Rising interest rates could cause higher unemployment, a drop in stock prices, and layoffs.
Impacts on housing markets
The rising interest rates have caused the housing market to collapse. In July, the average rate on a home loan was 5.5%, nearly double what it was a year ago. Despite the Fed's signal that it might start implementing credit-tightening measures, the rate on home loans has started to stabilize.
Although mortgage rates tend to move in tandem with the Fed's rate increases, they can also move in the opposite direction. For instance, a 30-year mortgage rate may reverse after the central bank increases. Other factors affecting the interest rate on a long-term mortgage include investors' expectations and the demand for U.S. Treasury.
If the U.S. economy goes into recession later this year or early next year, investors expect the Fed to reduce its key interest rate. This would cause the 10-year Treasury yield to fall. Since the Fed has already started to reverse some of its rate increases next year, the 10-year yield has dropped from 3.5% in June to around 2.8%.
Existing home sales have been declining for five straight months. In June, new home sales also fell. In many areas, there are few options for buying a home. Nationwide, the number of houses for sale has increased following the bottoming out of the housing market last year. According to the National Association of Realtors, there are currently 1.26 million homes for sale.
Impacts on debts, savings
If the Fed continues to raise interest rates, the rates on various types of debt, such as credit cards and home equity lines of credit, would follow the same path as the previous rate hike. This is because the prime rate, which is the central bank's rate, moves in tandem with the rate hike. This means that those who don't qualify for low-interest credit cards would be affected by the higher interest rates.
According to data from LendingTree, the average credit card rate has already reached 20%, the first time it has been above this level in over four years.
Unlike other types of financial instruments, such as money market accounts and savings, the interest rate changes made by the Fed do not usually affect the interest rate on certificates of deposit or loans.