The cost of borrowing money is going up.
That’s because the Federal Reserve, America’s central bank, on Wednesday raised its key interest rate 0.25%, the first increase since 2018. The central bank wants to tame the highest inflation rates that the United States has seen in 40 years.
What does it mean when the Fed raises interest rates?
The Federal Reserve sets the interest rates that banks charge each other for overnight loans to meet reserve requirements.
This rate, the benchmark federal-funds rate, influences the interest that financial institutions charge consumers to make purchases such as homes and cars, and finance student loans and credit cards. When the Fed raises its federal-funds rate, commercial rates follow in the same direction.
Since the pandemic began in March 2020, the range for this short-term, overnight interbank rate was 0.0%-0.25%.
The Fed this week raised the rate one-quarter of one percent, to a range between 0.25% and 0.50%, and signaled that it expects to lift rates as many as six more times this year. The Fed’s key interest rate has been a powerful tool in setting monetary policy. Lowering the rate revs up the economy by making it cheaper to borrow money while raising the rates puts on the brakes.
How much are interest rates going up?
Only a little bit now, but some estimate that the federal-funds rate could rise to 2% by the end of 2022.
Not everyone agrees on how high the Fed will go.
Moody’s isn’t sure the Fed will move beyond 2% “because there is significant uncertainty in the outlook and the Fed’s view of the appropriate path for the fed funds rate can change,” according to a March 17 research note. If oil prices continue skyrocketing, for example, the Fed may pause.
Credit card rates and auto loan interest rates are already high, said Lara Rhame, chief U.S. economist with FS Investments in Philadelphia. “Those won’t move as much as loans grounded in the banking system, such as construction and small-business loans, 18-month and two-year loans,” Rhame said. “Those will move up quickly with the Federal funds rate hike.”
Why now?
Worries about inflation and war have displaced concerns about the pandemic.
The Fed raised rates to protect the U.S. economy from soaring inflation and higher oil prices due to the Russian invasion of Ukraine. Higher interest rates can put the brakes on growth, but Fed chair Jerome Powell said solid hiring and wages show America’s economy is strong enough to withstand the hikes.
The Fed cut its forecast for GDP growth this year from 4% to 2.8%, but left forecasts for GDP growth in 2023 and 2024 at 1.8%. The unemployment rate is expected to drop to 3.5% this year and next year, while the Fed projected a slight rise to 3.6% in 2024.
The Fed expects inflation to hover at about 4.3% this year, dropping to 2.7% in 2023 and to 2.3% in 2024. According to the latest data from the Labor Department, over the 12 months ending in February, inflation jumped 7.9%.
Among the factors driving inflation are labor costs, a strong economy and supply chain problems. “Rate hikes only fix two out of the three of those,” Rhame said. Rising oil prices and Russia’s invasion of Ukraine, not captured in the latest inflation data, continue to exert an upward pressure on prices.
What does this mean for my student loans?
Most federal student loans have fixed interest rates, and a fixed-rate loan wouldn’t change, so your interest rate and payment remain the same.
“If you have a federal loan, this doesn’t affect you. Your rate is fixed,” said student loan expert Anna Helhoski.
Private student loans, however, often have variable rates, and “this rate hike affects borrowers in the private market immediately,” said Helhoski, who works for the NerdWallet personal finance website and app.
The rate hike adds an additional 0.25% to your student loan interest, she said. A private student loan lender determines interest rates based on credit history, the school you attend, and your course of study, according to the Consumer Finance Protection Bureau.
Your lender must tell you your rates. If you already have a loan, log in to your student loan account on your lender’s website or call your servicer to find interest rate information.
When federal student loan rates are reset in July, keyed off of 10-year Treasury bonds, that rate could be higher than today, Helhoski said.
Direct federal loans for undergrads charge 3.73% until July 1, 2022, 5.28% for graduate loans, and 6.28% for Parent Plus loans, according to the Department of Education.
“We don’t know what the rate will be for the 2022-2023 school year,” Helhoski said. Check your current interest rate on the Department of Education’s website: studentaid.gov/understand-aid/types/loans/interest-rates.
A total of 26.6 million people are expected to resume student loan payments on May 2 after being paused since March 13, 2020, and government agencies, advocates and lawmakers may extend yet again.
How much will mortgages cost now?
Mortgage interest rates aren’t directly tied to the federal-funds rate, but nonetheless these have moved up, too.
A 30-year fixed-rate mortgage averaged 4.16% in the week ending March 17, up from 3.85% the week before, according to Freddie Mac data on the St. Louis Federal Reserve website.
Home prices were up 17% year-over-year in 2021, Rhame said. “Could that prompt home prices to slow down a bit? That’s likely to happen as mortgage rates rise.”
There are other factors shaping the housing market, she added. “There’s still very short supply.”
