The Fed hike happened. We all expected it, but now we definitely need to make sure we’re equipped to deal with it. If you aren’t intimately familiar with the system, this is your chance to learn exactly what the hike will mean for you and your finances. Here’s a quick spoiler alert: it won’t be fattening your savings account.
What Is a Fed Hike?
You’ve heard so much about Fed rates in the past two years that you may be sick of it, but on the chance you’re still a little fuzzy on the actual mechanics, a simple explanation will suffice. Fed rates do not directly regulate interest run by banks, save for one exception: reverse repurchase operations (RRP). That’s a fancy name that refers to a specific form of borrowing that happens between banks.
Simply enough, banks are required to keep a certain amount of money on hand. Sometimes, maintaining that quota would require them to miss an opportune purchase or investment, so they regularly borrow from each other in order to make those investments and still meet regulation. These loans are only overnight, so they are extremely short term, and it is the interest on these specific loans that the Fed controls.
The Fed does manage other things that also have economic impacts, but these overnight loan rates are the topic of this discussion. So, seeing that the affected rates have nothing to do with your direct finances, it’s easier to understand why Fed rate changes have a filtered impact on your life. It is through a domino effect of sorts that the change will impact your finances. Let’s look at some of those effects.
Savings and CDs
Savings accounts and CDs have long been the ultimate in low-interest, safe investment. Since the crash of 2008, Fed rates have largely been linked to the historically low interest these investments have seen in recent years. Since a Fed hike doesn’t directly change these interest rates, can you expect any kind of filtered return? The short answer is no. First, the December hike was targeted at 0.25 percent. Considering the average return on savings accounts was 0.11 percent at the time of this writing, even if the Fed hike were to be fully mirrored on your savings account, you still would not be seeing significant returns.
There’s a bigger reason this change won’t help your savings account. Fed hikes are always done with a goal in mind, and while that goal is to change interest that will directly affect you, the Fed uses its tools behind the scenes to target loan and credit card interests more than savings or CDs.
Basically, short-term, variable, volatile interest rates have more impact on the greater economy, so that is the Fed’s focus. Using their tools (that extend beyond the simple rate hike we’re discussing), their goal is to pressure financial institutions to increase rates on money loaned.
It has much to do with controlling inflation and little to do with putting money in citizens’ pockets, and the end result is that, at least for now, savings and CDs with be largely ignored. It’s possible that you could see a fraction of a percent in increased interest by the end of 2017, but unless subsequent hikes are very aggressive, even that small fraction is unlikely.
What Will Be Affected
Since savings accounts aren’t the Fed’s goal, what interest rates are? There are two primary categories that are being pushed: variable interest credit cards and short-term loans. While mortgage and auto loan rates will probably see some trickle-down changes, any long-term loan with a fixed rate will be entirely unaffected.
Credit cards are a different story. The average American has thousands of dollars in credit card debt, and this single rate hike is expected to increase annual interest charges by $40 a year, on average. While that number alone isn’t a big deal to the individual, additional hikes throughout 2017 could easily turn this into a significant sum.
Student loans are another big item. While traditional student loans have a fixed federal rate, many students supplement them with personal loans, and those personal loans are typically variable interest. They also account for almost 25 percent of all student debt, and this is one of the primary sectors that will be hit by the hike.
Strategizing for the Future
Rate hikes always put a burden on consumers, but they are happening. For now, you can assume that money you owe will increase in interest faster than money that is owed to you, but the long-term expectations, for now, are that inflation will outpace the Fed hikes.
In fact, that is part of the Fed’s stated goals. Ultimately, what it means to you is that you want to be proactive on variable interest debt, and even consider refinancing into fix-interest consolidated loans if you can get a good deal. You’ve seen the numbers. The hikes will cost you money in the next year, but it shouldn’t be enough to break the bank.
Regards,
Ethan Warrick
Editor
Wealth Authority
