The Fed holds rates near zero yet some borrowing costs are already on the rise

Even though the Federal Reserve didn’t raise its benchmark rate Wednesday, the days of low rates are clearly numbered.

Reports of hotter-than-anticipated inflation have paved the way for the central bank to unwind last year’s bond buying. While the Fed said that interest rates will stay near zero for now, the tapering of bond purchases is seen as the first step on the way to interest-rate hikes.

That will inevitably impact the rates consumers pay.

In fact, rates are already rising for long-term borrowing costs, said Yiming Ma, an assistant finance professor at Columbia University Business School. “Likely that’s going to continue as the implementation starts actually happening.”

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The federal funds rate, which is set by the central bank, is the interest rate at which banks borrow and lend to one another overnight. Although that’s not the rate that consumers pay, the Fed’s moves still affect the borrowing and saving rates they see every day.

Since the start of the pandemic, the Fed’s historically low borrowing rates have made it easier to access cheaper loans and less desirable to hoard cash.

Once the central bank starts to reel in its easy money policies, consumers may need to work a little harder to protect their buying power.  

Here’s a breakdown of how it works.

For starters, when the Fed starts to slow the pace of bond purchases, long-term fixed mortgage rates will edge higher, since they are influenced by the economy and inflation.

The average 30-year fixed-rate home mortgage has already risen to 3.24%, according to Bankrate.

“If they haven’t already, now could still be a good time for some borrowers to consider refinancing,” said Jacob Channel, senior economic analyst at LendingTree. “Even though rates are rising, they’re still relatively low from a historical perspective.

“Nonetheless, the window for refinancers to get a sub-3% rate is rapidly closing.”

Currently, refinance borrowers with a good credit score can expect to see APRs around 2.85% for a 30-year, fixed-rate refinance loan, and 2.31% for a 15-year, fixed-rate loan, according to a Lending Tree.

Once the federal funds rate does rise, the prime rate will, as well, and homeowners with adjustable-rate mortgages or home equity lines of credit, which are pegged to the prime rate, could also be impacted.

But it isn’t all bad news, Channel added. “Higher rates could help dampen demand for homes somewhat, which could result in less dramatic home price growth, homes staying on the market for longer, and fewer bidding wars,” he said.

“This could actually make it easier for some homebuyers — like first-time buyers — to enter into the housing market.”

And it may still be a while before rates for home equity lines of credit, which stand at 3.87%, move up from the current “very low, very attractive levels,” added Greg McBride, chief financial analyst at Bankrate.com.

“It will take a succession of interest rates hikes before the accumulative effect on rates diminishes the appeal.”

Anyone shopping for a car will see a similar trend with auto loans. The average five-year new car loan rate is as low as 3.87%, while the average four-year used car loan rate is 4.52%, according to Bankrate.

Other types of short-term borrowing rates, particularly on credit cards, are also still cheap by historic standards.

Credit card rates are now 16.31%, down from a high of 17.85%, according to Bankrate, but most credit cards have a variable rate, which means there’s a direct connection to the Fed’s benchmark, and when the Fed raises short-term rates, credit card rates will follow suit.

“Rates won’t stay this low forever,” said Matt Schulz, chief credit analyst for LendingTree. “That makes it really important for people with credit card debt to focus now on paying it down as soon as possible.”

The good news here is that zero-percent balance transfer offers are back in a big way, he added. Cards offering 15, 18 and even 21 months with no interest on transferred balances are easy to find and banks are eager to lend, Schulz said.

Savers also need to take action.

The Fed has no direct influence on deposit rates; however, those tend to be correlated to changes in the target federal funds rate. As a result, the savings account rate at some of the largest retail banks is hovering near rock bottom, currently a mere 0.06%, on average.

Because the inflation rate is higher than savings account rates, the money in savings loses purchasing power over time. 

In addition, even when the Fed does raise it benchmark rate, deposit rates are much slower to respond.

“Based on history from 2015 to 2017, no significant increase in savings account rates are anticipated until the Fed is well underway with its rate hikes,” said DepositAccounts.com founder Ken Tumin.

“For consumers that are depositing, it’s good to pay attention to other options, Columbia’s Ma advised, such as “money market funds, bond mutual funds or bond ETFs.”

There are alternatives out there that will require taking on more risk but come with increasing returns, she said.

“This is especially important to consider as we enter a rate hike cycle at some point.”

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