The Federal Reserve just announced an increase to the federal funds rate. What does that mean? And more importantly, what does it mean for you?
Well, the federal funds rate essentially measures how much interest banks will charge other banks that need to borrow money to meet so-called "reserve requirements" that are mandated by the Fed. While these transactions between banks do not directly affect you, the ramifications of an increase in the federal funds rate will be felt in some areas of your life -- from your monthly credit-card payment to the next time you go deposit your paycheck.
Trying to understand the benefits and disadvantages of an rate increase can be difficult, but here's a look at how the federal funds rate hike will impact you:
A rising fed funds rate mean more money for you if you have an interest-bearing bank account. That's because as the rate increases, interest that banks pay on savings accounts, certificates of deposit and money-market accounts also typically increase. However, how much that changes depends on your bank. You can check your account's annual percentage yield to see how much more interest you'll be getting on your deposits.
But Mark Hamrick, senior economic analyst at Bankrate.com, said people shouldn't expect to see their accounts immediately flush with extra cash, as these changes take time to take effect. He said savers are usually some of the last people on the chain to be affected by a change in the federal funds rate.
Credit Cards and HELOCs
Many current or future borrowers are going to get hit with higher interest charges as a result of the fed funds rate's increase. That's because anything that has a short-term or variable interest rate -- such as credit cards or home equity lines of credit (HELOCs) -- typically moves in tandem with how the fed rate fluctuates. If the fed funds rate goes up, people will pay more interest on most of their loan obligations.
"In a rising interest time, borrowing will become pricier," Hamrick said.
But Robert Frick, corporate economist at Navy Federal Credit Union, said there's a hierarchy to which rates are impacted by first, and by how much.
Credit cards, personal loans and home equity lines of credit change almost immediately after a rate increase, and typically move by the same amount the Fed rate changes.
Mortgages and Car Loans
Existing 30-year fixed-rate mortgages will be unaffected because their interest rates are locked in and thus insulated from adjustments to the fed funds rate.
And for those hunting for a mortgage, rates might or might not increase slightly, said Ric Edelman, founder of Edelman Financial Services. "If Wall Street was expecting a bigger interest rate increase than the Fed actually did, then interest rates might need to come down," he said. "That increase can actually result in a decline in [mortgage rates]."
As for existing adjustable-rate mortgages (or "ARMS"), those won't charge higher rates if you're still in the loan's introductory-rate period, which is typically five or seven years. However, expect your ARM's rate to go up higher than it would have if you're out of the introductory period and facing a rate reset, which typically happens once a year.
"The interest rate on an adjustable-rate loan will be higher today than it was yesterday," Edelman said. He suggests people who have ARMs move to a fixed-rate mortgage when those first few years of low interest are up.
Auto loans won't be affected if you have one already, as they typically come with fixed interest rates. But if you're shopping for a new loan, be prepared to spend some more money, Edelman said.