The Federal Reserve promised months ago to take serious action to try to curb inflation in America. On May 5, they did just that, increasing the benchmark interest rate by a half-percentage point.
The half-percent uptick, which is the largest such increase in 22 years, follows a quarter-percent increase the central bank initiated back in March. That increase was the first one the Fed enacted in almost four years.
There’s been much talk about the interest rate hike, but what does it really mean for you? Let’s take a closer look.
The Reason for the Increase
Before the COVID-19 pandemic outbreak, the U.S. economy was riding high. Most economic measures were strong, including the stock market, the financing industry, and employment at large.
The pandemic upended all of that overnight.
In response, the federal government took many measures to help support Americans and the overall economy. Congress passed multiple economic relief packages that provided extra unemployment support, aid to state governments, and direct checks to millions of Americans.
At the same time, the Fed dropped the benchmark interest rate to near zero and significantly ramped up its purchases of bonds in an effort to stimulate the economy. It worked, as the economic recovery was rapid.
As life began to return close to normal, though, inflation began to rear its ugly head, thanks to a confluence of factors including issues with the supply chain, Russia’s invasion of Ukraine, and the extremely low cost to borrow money. Employment is now very strong again, yet inflation is high, erasing any gains in earnings.
The Fed’s actions are meant to slow down the economy, which the central bank hopes will put the brakes on inflation.
How Does This Impact You?
Debt Becomes More Expensive
The most common way that everyday Americans will feel the interest rate increase is with any debt they currently have that’s based on a variable interest rate, or any new debt they wish to take out.
The commonly-accepted formula is that every half-point increase in rate equates to $50 extra in interest paid for every $10,000 a person holds in debt. So, for example, if the rate on a variable-rate loan–such as a credit card with a $5,000 balance–increases by 0.50%, you’ll pay an extra $50 per month in interest.
You may not see this increase in rate immediately, as it could take a month or two for credit card companies to adjust their interest rates.
In addition, if you look to obtain new debt of any kind, the interest rate is likely to be higher than it was even a few months ago–for both variable and fixed-rate loans.
One of the areas that has been most affected by the Fed’s move is home mortgages. In the last year, the average interest rate on a 30-year fixed mortgage has increased roughly 2%, creeping above the 5% mark on average.
The National Association of Realtors laid out just how expensive this can be. A person who purchased a home valued at $250,000 with a 30-year fixed mortgage with an interest rate of 5.3% will now pay an additional $3,300 per year compared to how much they would’ve paid last year at this time.
That $275 per-month increase is likely to make it even more difficult for first-time homebuyers to get into the market.
Tech Stocks Could Be Hurt
The general consensus is that when interest rates rise, tech stocks fall. The impetus behind this theory is that most tech companies aren’t very profitable, if at all. The investment people make in these companies is for a big return in the long run.
But, when interest rates rise, bond yields get higher, too. That entices investors to sell off stocks in tech companies that aren’t profitable now for bigger returns in other areas. This was seen in the immediate aftermath of the Fed announcing its half-percent rate hike, and the Fed’s plans to continue increasing the rate throughout 2022.
One day after the rate hike was announced, the Nasdaq Composite dropped 4.9%. The industry that was particularly hit hardest was tech, where companies such as Tesla and Amazon saw decreases in value of 8.3% and 7.6%, respectively.
Savings Will Benefit
On the flip side, the impact of the raising interest rates isn’t all negative. Increases in the Fed interest rate will positively affect savings accounts.
The average account at an online bank increased yields by 4 basis points, up to 0.54%, for savings accounts in April. That same month, the yields for five-year CDs increased 47 basis points, up to 1.7%.
That’s a decent little bump for people who have money saved in these types of accounts. At the same time, though, it isn’t likely enough to offset increases in debt–or to outpace inflation, which is currently above 8%.
What the Fed Will Do Next
In addition to the half-percent increase the Fed announced in early May, the central bank also announced plans to increase the rate further throughout the year. In fact, most economists say they expect the federal benchmark rate to climb to 2% or more by the end of 2022.
Work With an Experienced Financial Advisor
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The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.