Here’s How a Federal Funds Rate Increase Could Affect You (and Your Debt)

The Federal Open Market Committee has announced another adjustment to the federal funds rate on March 21 — a quarter-point increase, bringing the rate’s range to 1.5% to 1.75%.

This increase is likely be the first of several in 2018. Many economists are predicting three to four quarter-percentage-point rate increases this year, according to the Wall Street Journal.

A quarter-point increase doesn’t sound like much, right? So why are we talking about this?

To better understand this news, we’ve put together a guide to understanding the federal funds rate and how it could affect your finances.

Federal Funds Rate, Defined

In order to understand what the federal funds rate increase means for you and your finances, let’s start with a definition.

The Federal Reserve defines the concept on its website, but, to be honest, it might read as a bit of mumbo-jumbo to commonfolk (i.e. me).

At its core, the federal funds rate is the interest rate banks use to lend one another money. This helps the Federal Reserve keep tabs on how much money banks have on hand.

“The higher the interest rate, the more expensive it is to borrow money,” The Penny Hoarder writer Lisa Rowan wrote last March when the rate increased. “A slightly higher interest rate slightly reduces the amount of money floating around, because it’s more expensive to borrow it in the first place.”

The Federal Open Market Committee sets the federal funds rates based on the country’s economic health. If the economy is doing well, typically the federal funds rates increase — making it more expensive to borrow — to prevent inflation. If the economy isn’t as robust, the rates will lower, making interest rates decrease. It’s the classic supply-and-demand scenario.

How The Federal Funds Rate Increase Might Affect Your Finances

Although the federal funds rate is designed to help stabilize the country’s economy, it could affect your personal finances, especially if you carry debt.

Here’s how:

1. Credit Cards

At the end of last year, Americans had racked up $808 billion in collective credit card debt, and unfortunately, those with credit card debt will notice the federal funds rate hikes the most.

Even a small increase in the federal funds rate will affect interest rates, explains Steve Allocca, the president of peer-to-peer lending platform LendingClub.

“The prime rate moves in lock step with the federal funds rate, and most credit cards have a floating interest rate tied to the prime rate,” he says.

“Most credit cards have a floor, so when the prime rate goes below a certain level, the rate doesn’t drop. But it doesn’t have an effective ceiling, so every time the prime rate goes up, the interest rate on your credit card balances are going to go up in lock step.”

If you see a quarter-point increase in the federal funds rate, you’ll likely see a quarter-point increase in your credit card interest rate over the next couple of months, Allocca continues.

“If you were to generalize, that’s the one [type of debt] that’d have the most impact from the federal funds rate increase,” he says.

The five federal rate hikes that have occured since December 2015 have resulted in credit card users paying $6.8 billion more in interest, according to WalletHub. The personal finance website predicts that number will increase by $1.6 billion this year.

A potential solution: Consolidate your credit card debt.

Debt consolidation is the act of lumping all of your credit card debt into one account by paying off your other accounts with a personal loan.

This can make paying off your debt easier (everything’s in one spot) and replace the high interest rates of multiple credit cards with one (ideally lower) interest rate of a personal loan.

A number of online marketplaces can help you find the best personal loan for you.

To start, try peer-to-peer lending site LendingClub. Enter how much you need to borrow to cover your credit card debt, and check your rate. Because it’s a soft inquiry, it won’t affect your credit score unless you actually apply.

2. Private Student Loans

If you have an existing fixed-rate government loan, you won’t see a change in your interest rates. Whew.

However, back in December when there was another federal rate increase, the New York Times reported that interest rates on private variable-rate loans could increase.

The increase likely won’t push you into the red. We’re talking about having to pay an extra $2,000 over the next 20 years on a $30,000 loan. That’s about an extra $8 a month.

If the rates continue to increase, though, the effects could stack.

A potential solution: Prioritize your debt payoff plan, or refinance your student loans.

If you have a mix of federal student loans and private student loans, consider prioritizing which ones you work to pay off first.

Paying off your private student loans before rates increase too much could be a smart money move. Then you’re left with federal student loans, which are set at a fixed rate.

Another option is to refinance your private student loans to secure a better, lower interest rate.

Chat with your current private lender, or shop around on an online marketplace like Credible. The Penny Hoarder interviewed two guys who were able to save thousands on student loans after refinancing.

3. Mortgages

If you’ve taken out a home equity line of credit (HELOC) or an adjustable-rate mortgage (ARM), your interest rates could increase. However, this increase would likely be slight because mortgage terms tend to be long (think: 15 to 30 years), says the New York Times.

The APR on fixed-rate mortgages could also increase, but this wouldn’t affect those who already have mortgages — just new borrowers.

Sometimes, though, banks predict the federal rate hike and will slowly build up interest rates. Mortgage markets have already accounted for this most recent anticipated hike, says WalletHub.

A potential solution: Refinance to a fixed-rate mortgage.

If you have a HELOC or ARM and interest is becoming unbearable, consider refinancing to a fixed-interest rate mortgage. However, this shouldn’t be a willy-nilly decision.

Follow NerdWallet’s guide to determining if a fixed-rate mortgage is right for you. Remember, fixed-rate mortgage interest rates are also increasing.

If this could be the right choice for you, consult your bank or mortgage broker or shop around online.

4. Auto Loans

If you already have an auto loan, it’s likely at a fixed rate, so you won’t notice a change.

If you want to take out a new auto loan, an increase in the federal funds rate will likely result in an increase in your auto loan rate. But, like mortgages, it shouldn’t be a big deal.

The New York Times reported monthly payments on new auto loans increasing “just a few dollars more.”

The current auto loan interest rates hover around 4.4% for a 48-month new car loan, according to BankRate. The rate has certainly increased since November 2017; however, it’s been slight — about 0.2 percentage points.

A potential solution: Cut costs elsewhere.

If the increase in interest affects your ability to make on-time payments, you could refinance your loan.

You could also try to cut costs elsewhere, like getting new quotes for your car insurance.

And if you look through a digital marketplace called SmartFinancial, you could be getting rates as low as $22 a month — and saving yourself more than $700 a year. 

It takes one minute to get quotes from multiple insurers, so you can see all the best rates side-by-side. Yep — in just one minute you could save yourself $715 this year. That’s some major cash back in your pocket.

So if you haven’t checked car insurance rates in a while, see how much you can save with a new policy.

You Can’t Control the Federal Rate Hike, But You Can Control This

Unfortunately, you can’t control the federal rate hike. The Federal Reserve is going to make sure it’s set at a place that’s going to help the country’s economy.

What you can do, is take control of your finances.

Before taking out any new debt, read the fine print. Is it a fixed-rate loan? Or an adjustable or variable loan? Know the differences and how they could affect your finances.

You also need to keep tabs on your interest rates. Sure, your credit card company will send you a notification that your rates have increased, but higher rates aren’t something it’s going to shout from the mountaintops.

“In a rising-rate environment, it’s very, very easy to find that cost of debt service go up very quickly and not even notice it,” Allocca warns.

“We’ve been living in a really unusual time where the federal funds rate has been effectively zero since December 2008… so we aren’t going to remain in this extreme low interest rate environment.”

That’s why, he explains, it’s important to take stock of your options, gain control of your debt, seek lower rate options and map out a plan to pay off your debt.

Carson Kohler ([email protected]) is a staff writer at The Penny Hoarder.