The Impact of Federal Reserve Interest Rates on Consumers

The Federal Reserve is the most potent economic control entity in the United States, and its ability to adjust interest rates is critical in fighting inflation. As the Fed strives to reduce the inflation rate without causing a recession, it is essential to understand how interest rates work and how they can affect consumers. This article will provide an overview of the current interest rate set by the Federal Reserve, the factors that go into setting consumer interest rates, which consumers are hit hardest by rate hikes, and the implications of rising interest rates on the housing market.

Current Interest Rate

At its last meeting on February 1, 2021, the Federal Reserve raised interest rates a quarter of a percentage point to 4.75%, where it remains. This is the highest rate in 15 years and marks the eighth consecutive time the Fed has increased interest rates. This increase affects the cost of borrowing for various consumer loans products, such as credit cards, mortgages, home equity lines of credit, auto loans, and student loans.

Factors Affecting Consumer Interest Rates

John Carusone, president of the Bank Analysis Center, explains that the interest rate set by the Fed is the starting point for how banks and other consumer lenders set the rate that they charge consumers. This rate is designed to reflect the cost of credit, which includes the cost of having enough money to loan, the operating expenses of the lender, and the potential for increased risk of consumer loan delinquencies or defaults.

Donald Klepper-Smith of DataCore Partners adds that current data on auto loan delinquencies best illustrate the risk component for lenders. He states that the percentage of loans 30 days past due is nearing 10%. Carusone further notes that lenders also factor in their desire to increase profits, which results in a hypothetical interest rate for a consumer that could be 7.5% or more.

Consumers Hit Hardest by Rate Hikes

Frank Chen, an associate professor at the University of New Haven’s School of Business, explains that any increase in interest rates hits two groups the most complex: home mortgage holders with adjustable rate mortgages, home buyers who are considering getting that type of loan, and individuals with credit cards whose credit scores are at 660 or lower. In addition, he notes that home mortgages account for about 70% of combined household debt, making interest rate increases especially problematic for mortgage holders with adjustable-home loans.

Implications on the Housing Market

Consumer interest in adjustable-rate mortgages has been growing since the start of the pandemic in March 2020. With rising real estate prices making homeownership more difficult, adjustable-interest rates accounted for 10% of all new home loans as of the middle of last year after being as low as 3% just two years earlier, according to data from the Mortgage Bankers Association.

Related Facts

• The Federal Reserve has seven more meetings this year at which it can take action on interest rates, with the next one scheduled for March 22.
• The current interest rate is the highest it has been in 15 years.
• The percentage of loans 30 days past due is nearing 10%.
• Home mortgages account for about 70% of combined household debt.
• Adjustable interest rates accounted for 10% of all new home loans in the middle of last year.

Key Takeaway

The Federal Reserve’s ability to adjust interest rates is a powerful tool in fighting inflation, and it is essential to understand how interest rate hikes can affect consumers. This article has provided an overview of the current interest rate set by the Federal Reserve, the factors that go into setting consumer interest rates, which consumers are hit hardest by rate hikes, and the implications of rising interest rates on the housing market.

Conclusion

Interest rate hikes can significantly impact consumers, especially those with adjustable-rate mortgages or credit scores below 660. Therefore, consumers need to be aware of the factors that go into setting consumer interest rates and the implications of rising interest rates on the housing market. By understanding the impact of Federal Reserve interest rates, consumers can make more informed decisions about their finances.