The era of floor rates is almost over.
The central bank will relax aggressively last year’s bond purchases ahead of schedule after recent inflation reports continued to show prices rising sharply.
While the Federal Reserve said on Wednesday that interest rates will remain near zero for now, the rapid reduction in bond purchases is seen as the first step on the way to higher interest rates next year.
“For consumers, it’s written on the wall that interest rates should start to rise 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 each other overnight. Although this is not the rate consumers pay, Fed decisions still affect the borrowing and savings rates they see every day.
“The reduction in the purchase of long-term assets is likely to reflect a faster rise in long-term interest rates and this should affect borrowing and saving,” said Yiming Ma, assistant professor of finance 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 coming to an end, consumers will pay more to borrow. Some already are.
As the Fed scales back bond purchases, long-term fixed rates mortgage rates will increase slightly, as they are influenced by the economy and inflation.
For example, the average 30-year fixed rate mortgage has already increased at 3.24%, and is expected to climb to nearly 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 per month at 3.2%, while it would cost you $1,432 at 4%. That’s a difference of $135 per month, or $1,620 per year, and $48,600 over the life 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 though those days are numbered.
Currently, borrowers who refinance and have a good credit rating can expect to find APRs of around 2.65% for a 30-year fixed rate refinance loan and 2.35% for a fixed rate loan. 15-year fixed rate, according to Lending Tree. .
“Refinancing a mortgage can take another $100 to $200 off your monthly payment, which provides valuable breathing room when the cost of so many other things is rising,” Bankrate’s McBride said.
Once the federal funds rate rises, the prime rate will also rise, and homeowners with variable rate mortgages or home equity lines of creditindexed to the prime rate, could also be impacted.
But there’s also a benefit here: “Because higher rates are likely to reduce demand for new homes, potential buyers could find themselves with a greater choice 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, including on credit cardare also still cheap by historical 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 is a direct link to the Fed’s benchmark, so these rates won’t change much until the Fed takes action.
However, “the prospect of interest rate hikes in the not-too-distant future means it’s really, really important that people focus on reducing their card debt today,” said Matt Schulz, Chief Credit Analyst at LendingTree.
If you owe $5,000 on a credit card with a 19% APR and put $250 a month towards the balance, it will take 25 months to pay it off and cost you $1,060 in interest charges. If the APR hits 20%, you’ll pay $73 more in interest only.
The good news here is that there are still plenty of zero percent balance transfer offers out there, Schulz said.
Cards offering 15, 18 and even 21 months interest-free on transferred balances are “absolutely worth considering for anyone deeply in debt.”
For saversThis is an other story.
The Fed has no direct influence on deposit rates; however, these tend to be correlated with changes in the target federal funds rate. As a result, savings account rates at some of the larger retail banks hovered near the bedrock, currently just 0.06%, on average.
Moreover, when the Fed raises its benchmark rate, deposit rates are much slower to react, and even then only gradually.
If you have $10,000 in a regular savings account, earning 0.06%, you will only earn $6 in interest per year. In an average online savings account paying 0.46%, you could earn $46, while a five-year CD could earn nearly double that, according to Ken Tumin, founder of DepositAccounts.com.
However, since the rate of inflation is now higher than all of these rates, the money saved loses purchasing power over time.
“For consumers who are depositing, it’s good to pay attention to other options, advised Columbia’s Ma, such as ‘money market funds, bond mutual funds or bond ETFs.’
There are alternatives 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 be a good idea to look at different options.”