The U.S. Federal Reserve Bank just raised interest rates a quarter of a percent. How does that actually work and at what point does it impact your finances?
Eight times a year, the Fed’s Federal Open Market Committee (FOMC) meets to discuss policy changes.
One of the main decisions the central bank faces is whether to change the interest rate imposed upon interbank loans, which is known as the federal funds rate.
Federal Funds Rate
At its core, the federal funds rate dictates the costs associated with one bank lending reserve funds to another. But, when this rate changes, it doesn’t just affect financial institutions; it impacts you too.
The federal funds rate can alter interest rates on products like mortgages, car loans, and credit cards. This occurs because it shifts the prime lending rate, which is the base amount banks charge consumers.
Here’s how the outcome of Federal Reserve meetings can ultimately impact the interest rates on debt you have now or that you might take on in the future.
Fixed Rate Debt
Whether you’ll see a change in your debt interest rates depends on one thing: whether your rate is fixed or adjustable.
Fixed-rate installment debts have interest rates that are largely set in stone. The loan contract outlines a specific interest rate, and that is what you’ll pay. This means, even if the federal funds rate goes up, you shouldn’t see a change.
In most cases, fixed-rate revolving debts, like credit cards, won’t change either. However, a bank can attempt to change your rate. Typically, they must notify you in advance and give you a chance to opt out. If you opt out, they may close your account, but it usually lets you avoid an interest rate increase on the amount you still owe.
Floating Rate Debt
An adjustable or variable rate debt is different, regardless of whether it is an installment or revolving form of credit. In most cases, the prime rate plus a specific additional amount, such as 5 percent, is what determines what you pay.
Since the prime rate is part of the ongoing calculation, if the Fed’s rate change impacts the prime rate, your interest rate shifts accordingly.
How Your Rate Will Change
What the Fed decides to do during their meeting determines if and how your rate will likely change. Just because the FOMC gets together that doesn’t mean they’ll change the federal funds rate.
If they don’t change the rate, then your adjustable interest rates will probably stay the same. Similarly, your rates will rise if they increase the federal funds rate.
The Federal Reserve can also lower the federal funds rate. When this happens, if your interest rate is tied to the prime rate, you may end up paying less in interest.
Obtaining New Credit
The federal funds rate has a significant impact on interest rates for new forms of credit. In fact, just the anticipation of a rate change can cause banks to change their offerings.
If they expect the federal funds rate to go up, banks may increase their interest rates on new accounts in advance. This lets them offset the rising cost, even though it hasn’t yet come to pass.
Similarly, if they anticipate a decrease, new accounts may have lower interest rates. And, if the federal funds rate isn’t likely to change, banks may keep their rates the same.
Ultimately, understanding how the Federal Reserve meetings and federal funds rate impacts you helps you make smarter credit decisions. Now, you know how a rate change can affect your existing debts, as well as any new accounts.
Do you worry about rising interest rates after Federal Reserve meetings? Tell us about it in the comments below.
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