What the Federal Reserve rate hike means for U.S. households

[March 22, 2018]  By Kate Duguid

NEW YORK (Reuters) - The effects of the Federal Reserve interest rate hike announced on Wednesday will extend beyond corporate America to household budgets.

Most people will see at least a minor impact on their credit card statements in the next few billing cycles, while those with adjustable-rate mortgages, home equity lines of credit, auto loans and other loans with variable rates of interest will be hit hardest.

Credit cards with fixed interest rates and annual percentage rates that don't change for a set period of time won't be immediately affected.

Fixed-rate mortgages are also going to become more expensive, which could have a chilling effect on the real estate market. Higher interest rates typically depress home values by making monthly mortgage payments more expensive.

The Fed lifted its benchmark overnight lending rate by a quarter of a percentage point to a range of 1.50 percent to 1.75 percent at the end of a two-day policy meeting on Wednesday. The U.S. central bank also forecast at least two more hikes for 2018, signaling growing confidence in the strengthening economy, which could lead to more aggressive future tightening.

"The cumulative effect (of rate hikes) can be quite significant," said Greg McBride, chief financial analyst for Bankrate.com.

WHICH CONSUMER RATES WILL BE MOST AFFECTED?

The average rate on a five-year Treasury-indexed adjustable-rate mortgage is currently about 3.67 percent, according to Freddie Mac. ARM rates are modified annually, so a 0.25 percentage point increase in the rate in March wouldn’t have an immediate effect. But when it does kick in, it could add up to $1,250 a year to interest payments on a $500,000 mortgage.

That mortgage owner could pay an additional $312.50 a month, or $3,750 a year, in interest if the Fed follows through with two more quarter-point hikes this year.

The rate hike on Wednesday could add $12.50 a year in interest to a credit card with a balance of $5,000 and an interest rate of 14.99 percent, the average in the fourth quarter of 2017, according to Fed data.

That doesn't sound like much. Even $37.50 a year, the amount three quarter-point rate increases this year would add, may not shock households.

But consider that approximately $62.50 a year has already been added as a result of the Fed's previous five rate hikes since late 2015, and interest payments may be up by $100 at the end of the year.

WHAT HAPPENS TO HOME EQUITY CREDIT LINES?

Interest rates on home equity credit lines are lower, at around 5 percent. "For somebody with a $30,000 home equity line, a quarter-point rate hike increases the minimum payment by $6 a month. But, this now being the sixth interest rate hike, the cumulative effect since December 2015 is that a $30,000 home equity line now carries a minimum payment that is $37 a month higher," McBride said.

A shopper walks down an aisle in a newly opened Walmart Neighborhood Market in Chicago in this September 21, 2011 file photo. REUTERS/Jim Young/Files

Those relationships are not quite so neat in practice. The federal funds rate, which the Fed determines directly, sets the rate at which banks lend money to one another. But there are more factors that determine the interest rate on a consumer loan.

"For every 100-basis-point increase in the fed funds rate, historically, it has been the case that the adjustable-rate mortgage rate would go up by 70 basis points," said Michael Cox, founding director of the O'Neil Center for Global Markets and Freedom at Southern Methodist University in Dallas, Texas.

ARE RATE HIKES A SIGN THE ECONOMY IS OVERHEATING?

U.S. economic strength is evident with the unemployment rate at a 17-year low and companies receiving windfalls from President Donald Trump's tax cuts, which they may reinvest to create jobs and improve wages.

But U.S. wage growth has remained sluggish and household budgets are tight. Though wages improved in January at the best pace since 2009, worker pay hasn't made significant improvements since the 2007-2009 recession.

There is evidence in rising debt levels: American households owed a record high total of $13.15 trillion at the end of 2017, according to data from the New York Fed.

If wages don't rise as rate hikes mount, contracted spending could eventually lead to a broader economic slowdown.

IS THERE ANY GOOD NEWS WITH RATE HIKES?

Savers benefit as yields on savings accounts and certificates of deposit edge higher. The average national savings account interest rate was 0.6 percent before the Fed began raising rates in 2015, according to FDIC data. It is now 0.7 percent.

Rates on a 36-month certificate of deposit have gone from 0.48 percent to 0.65 percent. There are, however, internet banks including Synchrony <SYF.N> and Goldman Sachs' <GS.N> Marcus that are engaged in an arms race of raising rates on savings accounts, which are 1.55 percent at the upper end, and CDs.

(Reporting by Kate Duguid; Editing by Jennifer Ablan and Paul Simao)

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