Federal Reserve Chair Jerome Powell is telegraphing his first punch in the fight against inflation — his intention to support a 25 basis-point increase on a benchmark interest rate, the first in a number of potential rate hikes this year.
Now it’s time for consumers to make their own maneuvers, particularly those who are planning to pay down credit-card debt or build up their savings in 2022.
By itself, a quarter-percentage-point increase will not make a big difference to a credit card’s annual percentage rate (APR) or their savings account’s annual percentage yield (APY), experts say. But stack several rate increases together and consumers will start to feel the pinch, they note.
In Congressional testimony Wednesday and Thursday, Powell previewed what’s he’s considering at a crucial policy meeting scheduled for mid-March. That way, markets do not have to wait in the lurch when there’s already so much uncertainty — due to Russia’s invasion of Ukraine — and they aren’t blindsided when the increase happens to the federal funds rate now near zero.
“I do think it will be appropriate to raise our target range for the federal funds rate at the March meeting in a couple of weeks. And I’m inclined to propose and support a 25-basis-point rate hike,” he told lawmakers Wednesday.
On Thursday, he reiterated plans for a 25-basis-point increase and said he supports a “series” of 2022 hikes. If price inflation rates stay high, the Fed would be ready with rate hikes exceeding a quarter percentage point, Powell said.
Markets liked the certainty, and it’s a helpful heads up for consumers because the federal funds rate strongly influences a credit card’s APR and a savings account’s APY. Here’s more on that relationship:
Added credit-card costs
If a rate hike does comes this month, it could be April or May when credit-card holders see the higher APR reflected on their bill, said Matt Schulz, chief credit analyst at LendingTree. For anyone with credit-card debt, “any rise in rates is unwelcome, but the truth is that the Fed’s move in March isn’t likely to rock most people’s financial world, if it is only a quarter-point increase. The danger comes if the rate increases keep coming — and in bigger chunks.”
Consider this scenario:
A person carries a balance of $5,000 and makes $250 monthly payments, with a 16.44% APR (the average credit card interest rate in 2021’s fourth quarter, according to the Fed). To pay off the balance, the person will pay $884 in interest, Schulz said.
In comes a 25-point basis point increase:
That would bring the APR to a potential 16.69% because the prime rate — which issuers use to make their credit-card rates — historically absorbs the full amount of the federal funds rate increase, Schulz said. Now the same person is paying $900 in interest to pay down the balance, a $16 increase over the life of the loan, he said.
And another 25-basis-point increase:
With an APR of 16.94%, that turns into $917 in interest, an additional $32 during the loan’s duration.
If there are six, quarter-percent rate increases — which isn’t out of the ballpark when some observers say there could be seven hikes — that turns into a 1.5% rise for APR, Schulz said. Now the borrower has to pay $985 in interest, he said. That’s $101 extra during the life of the loan.
In a time of high inflation, an extra $101 being paid to interest instead of groceries or gas will be a tough reality for families living paycheck to paycheck. Average hourly earnings were flat from January to February, but up 5.1% year-over-year according to Friday’s jobs report.
Americans had approximately $860 billion in credit-card debt during 2021’s fourth quarter, according to the Federal Reserve Bank of New York. Borrowers had an average $4,857 in credit-card debt during the third quarter, according to TransUnion
TRU,
one of the big three credit bureaus.
It’s worth noting that some rates will be higher depending on a cardholder’s credit history. In February, the average rate for all new card offers was 19.53%, according to LendingTree.
Higher savings-account yields
“The good news about interest-rate hikes is that consumers who put their money in high-yield savings accounts will grow their money faster so continuing to shore up savings this year will yield more returns than last year,” said Gannesh Bharadhwaj, general manager of credit cards at Credit Karma
INTU,
Savings accounts are a place to safely store easy-to-access cash, rather than to reap large returns. Extra interest yields after a rate hike will be modest at first but can pile up depending on how many rate increases occur, said Ken Tumin, founder and editor of DepositAccounts.com.
Right now, an online savings account has an average 0.49% APY, he said. Historically, rate increases haven’t all been passed along to the APY, at least at first, Tumin said.
A 25 basis point hike could mean a potential average APY around 0.55% – 0.6%, he estimated. If a savings account has $10,000, that little step up bears an extra $10, Tumin said.
But the talk is of multiple rate increases. If there are six, quarter-percentage-point increases, that same $10,000 account could produce an extra $100 in a year, he estimated.
Online savings accounts are the places to find the elevated APYs, not the “brick and mortar” banks, Tumin said.
During the previous rate-hike cycle from 2015 to 2018, there were three, quarter-point increases “before the average high-yield savings account APY had any significant gain,” he noted. “The rise may be faster this time due to high-yield savings account rates that have fallen to levels much lower than the bottom levels before 2015.”
‘A marginal impact’ for mortgage rates
“For housing, the Fed’s short-term rate has a marginal impact on mortgage rates,” said George Ratiu, senior economist and manager, economic research at Realtor.com.
There’s a different Fed action connected to those rates, he said. Along with dropping the federal funds rate during the pandemic’s early days, the central bank also bought up Treasury debt and agency mortgage-backed securities. The central bank has decided it’s a good time to end that.
From 2020 to 2021, those Fed purchases injected liquidity and sent mortgage rates to the basement, Ratiu said. “As the Fed announced it planned to finalize its tapering of [mortgage-backed securities] purchases later this month, we have seen rates surge to highs not seen since mid-2019.”
So prospective homeowners are already paying for Fed actions. The average 30-year fixed mortgage rate hit 3.76% this week, Freddie Mac
FMCC,
said. To put that in context, the 30-year fixed mortgage rate was closer to 2.7% a year ago.
One basis point is equal to one-hundredth of a percentage point. It’s major shift from just a few weeks earlier when the average rate for the 30-year loan jumped to the highest level since May 2019, close to 4%.
February’s median listing came to $392,000, according to Realtor.com. Compared to a year ago, a buyer would pay $278 more on their monthly mortgage, Ratiu noted. That’s more than $3,300 added to the buyer’s yearly financial burden.
“Additional increases in mortgage rates will further squeeze buyers’ budgets and may limit first-time buyers’ ability to qualify for a mortgage, especially with prices continuing to advance,” he said.