On Wednesday, December 14, the Federal Reserve raised its key short-term interest rate by a quarter-point, from 0.5% to 0.75%, which is still considered low. Most banks then raised their prime rate to 3.75% from 3.5%.
It was the second rate hike in 13 months. For most of the last decade interest rates were untouched, in an attempt to improve the economy after the financial crisis. If you applied for a credit card or even a mortgage, these low interest rates certainly helped.
The increase, which is subtle, wasn’t entirely surprising, partly because 2016 has been a year of relatively robust economic growth. In fact, more than 2 million jobs have been created in the last year, and the unemployment rate fell to about 4.6%, the lowest it has been since the summer of 2007.
Low interest rates give consumers more borrowing power. When consumers spend more, the economy grows. Higher interest rates encourage people to save more, and borrow less, and reduces the amount of money in circulation. This slows the rise in prices. Learn more about how interest rates work.
One of the few surprises from the Fed’s announcement is that in 2017, there may be two, or three, additional interest rate increases. JPMorgan Chase’s head economist, James Glassman, offered this analysis:
“Ideally, the Fed’s policies will prolong the current business cycle and keep the economy operating at its peak potential for as long as possible. In the past, the top of every business cycle has generated imbalances as the economy began to overheat. But as we approach the current peak, slightly higher interest rates may effectively discourage the creation of the asset bubbles and bad investments that could lead to the next recession.”
Here’s what the interest rate increase may mean for you:
- Checking, savings, CDs & IRA CDs: Most banks will not automatically change deposit rates, because they aren’t tied directly to the prime lending rate. The prime lending rate is used for pricing short- and medium-term loan products, such as credit cards and home equity lines of credit. (This infographic explains more about the prime lending rate.)The good news for people with savings accounts is that they may start seeing larger returns, at least in the long term.
- Credit cards: Most credit cards carry a variable interest rate. So, credit card interest rates will likely go up—but modestly. It probably won’t affect your ability to pay your bills each month.
- Home Equity Lines of Credit (HELOC) and other variable-rate products: In general, the rate that banks charge on many HELOCs, and other lines of credit is a variable rate, so they will be affected, but only slightly since the rate hike is only a quarter point.
- Adjustable-rate mortgages: These mortgages, often called ARMS, are tied to a different index which can change only at specific time periods, usually annually.The rate hike could cause your mortgage rate to increase on your next rate change date.
- Existing fixed-rate loans: Interest rates on car loans, fixed-rate mortgages and other existing fixed-rate loans won’t be affected. Currently, an average mortgage rate is about 4%. Going forward, that may increase, but mortgage rates vary from customer to customer, based on any number of factors.