To help stave off rising inflation, the Federal Reserve announced Wednesday a benchmark interest rate hike of 0.25%, the first increase since 2018, in what looks to be the first of many rate hikes to follow.
With inflation up 7.9% year-over-year — well above the target rate of 2% — the central bank has raised its effective federal funds rate from 0.00-0.25% to 0.25-0.50%.
The central bank’s federal funds rate is an interest rate used to guide overnight lending among U.S. banks, but it also influences the prime interest rate, which is what lenders use to determine how much interest you’ll pay on credit cards, mortgages and other loans.
By raising the federal funds rate, the central bank increases the cost of borrowing money, which discourages spending. This, in turn, can reduce inflation.
However, the immediate impact of an 0.25% interest rate hike to consumers’ wallets will be minimal, says Greg McBride, senior vice president and chief financial analyst at Bankrate.
“The impact of a single quarter-point interest rate hike is pretty inconsequential on household finances,” says McBride.
Loans or financing tied to the prime rate — known as a variable rate — will be impacted by the rate hike, so it’s likely that interest rates will rise slightly on mortgages, auto loans, home equity lines of credit, credit cards and private student loans.
Using a car loan as example, McBride says that a quarter-point increase in interest rates is only going to be a difference of about $3 in interest on a $25,000 loan. “Nobody’s gonna have to downsize from a compact to an SUV” as a result of today’s hike, he says.
As for mortgages, the average rate for a 30-year fixed rate mortgage is 4.27% as of Wednesday, an increase of more than 1% compared with last year. This already reflects widely expected interest rate hikes, including the one announced today, as well as rising inflation, McBride says.
That said, McBride warns that Wednesday’s rate hike isn’t “a one-and-done” and more rate hikes are expected over the “next year or two.”
“It’s going to take a number of rate hikes and a number of months before we start to see any impact on inflation,” says McBride.
For many consumers, the first rate increase might increase their interest payments on loans by only a few dollars per month, but successive rate hikes within a year will add to that total.
“The cumulative effect of all of those interest rate hikes — they can have a significant impact on household finances, as well as the job market and economy overall,” says McBride.