- As the central bank aggressively tapers its emergency stimulus efforts, consumers will see interest rates rise.
- Some borrowing costs are already higher.
- Don't expect deposit rates to keep up.
The days of rock-bottom rates are nearly over.
The central bank will aggressively unwind last year's bond buying sooner than originally planned after recent reports on inflation continued to show a sharp rise in prices.
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While the Federal Reserve said Wednesday that interest rates will stay near zero for now, the quick tapering of bond purchases is seen as the first step on the way to interest-rate hikes next year.
"For consumers, the writing is on the wall that interest rates are likely to start climbing in 2022," said Greg McBride, chief financial analyst at Bankrate.com.
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.
"Reducing the purchase of long-term assets is going to likely reflect a faster increase of long-term interest rates and that should affect borrowing and saving," said Yiming Ma, an assistant finance professor at Columbia University Business School.
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.
Now that the central bank's easy money policies are nearing an end, consumers will pay more to borrow. Some already are.
As the Fed tapers its bond purchases, long-term fixed mortgage rates will edge higher, since they are influenced by the economy and inflation.
For example, the average 30-year fixed-rate home mortgage has already risen to 3.24%, and is likely to climb to near 4% by the end of 2022, according to Jacob Channel, senior economic analyst at LendingTree.
The same $300,000, 30-year, fixed-rate mortgage would cost you about $1,297 a month at 3.2%, while it would cost $1,432 at a 4% rate. That's a difference of $135 a month, or $1,620 a year, and $48,600 over the lifetime of the loan, according to LendingTree.
Fortunately, there is still time for refinancers with good credit to get a rate below 3%, Channel added, even if those days are numbered.
Currently, borrowers who are refinancing and have a good credit score can expect to find APRs around 2.65% for a 30-year, fixed-rate refinance loan, and 2.35% for a 15-year, fixed-rate loan, according to Lending Tree.
"Refinancing a mortgage can still trim $100 to $200 off of your monthly payment, and that provides valuable breathing room when the cost of so many other things are on the rise," Bankrate's McBride said.
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 there is an upside here, as well: "Because higher rates are likely to decrease demand for new housing, would-be homebuyers might find themselves with a greater selection of homes to choose from in 2022," Channel said.
And "even at 4%, rates would still be relatively low from a historical perspective," he added.
Other types of short-term borrowing rates, particularly on credit cards, are also still cheap by historic standards.
Credit card rates are currently around 16.3%, down from a high of 17.85%, according to Bankrate. Since most credit cards have a variable rate, there's a direct connection to the Fed's benchmark, so those rates won't change much until the Fed makes a move.
However, "the prospect of interest rate hikes in the not-too-distant future means it is really, really important for folks to focus on knocking down their card debt today," said Matt Schulz, chief credit analyst for LendingTree.
If you owe $5,000 on a credit card with an APR of 19% and put $250 a month towards the balance, it will take 25 months to pay it down and cost you $1,060 in interest charges. If the APR edges up to 20%, you'll pay an extra $73 in interest alone.
The good news here is that there are still plenty of zero-percent balance transfer offers available, Schulz said.
Cards offering 15, 18 and even 21 months with no interest on transferred balances are "absolutely worth considering for anyone who is deep in debt."
For savers, its a different story.
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 has been hovering near rock bottom, currently a mere 0.06%, on average.
Further, when the Fed does raise it benchmark rate, deposit rates are much slower to respond, and even then, only incrementally.
If you have $10,000 in a regular savings account, earning 0.06%, you'll make just $6 in interest in a year. In an average online savings account paying 0.46%, you could earn $46, while a five-year CD could pay nearly twice as much, according to Ken Tumin, founder of DepositAccounts.com.
However, because the inflation rate is now higher than all of these rates, the money in savings loses purchasing power over time.
"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.
"Banks have been notoriously slow to increase what depositors can earn on their accounts," Ma added. "It may make sense to look at different options."