As widely expected, the Federal Reserve announced a quarter-point rate hike at the end of its two-day meeting on Wednesday – almost two years to the day after the central bank cut interest rates to zero to cushion the blow of a deep recession, which was triggered when the United States shut down in the early days of the pandemic.
The Fed announced that it would raise the federal funds rate to a range of 0.25% to 0.50%, a move that is likely just the start of a longer cycle of rate hikes. the CME FedWatch tool forecasts a roughly 35 percent chance that the federal funds rate will be between 1.75 and 2 percent by the end of the year.
Looking further ahead, there is less certainty – but more incremental rate hikes are expected. At the July 2023 Fed meeting, there is about a 50 percent chance that it will be somewhere in the 2.25 to 2.75 percent range.
It’s still a low benchmark in relative terms, but experts say it could still have a profound impact on consumer spending, which powers about 70 percent of America’s economy. Credit card borrowers, homebuyers and small business owners need to be prepared for the end of the easy money era, they say.
Ted Rossman, senior credit card industry analyst Bankrate.com, said credit cardholders who revolve balances month-to-month will be among the first to notice the impact of tighter monetary policy. “Rate hikes are passed through to existing debt pretty much immediately, within a month or two,” he said.
Although Fed interest rates have been kept near zero for the past two years, the current APR, or APR, for credit cards is already within 2 percentage points of its April 2019 record high of just under 18 percent. “They’ve been padding the margins for the last few years,” he said.
Rossman predicted that the Fed’s path to normalizing interest rates will push those APRs even higher.
“By the end of the year we could well be on a new record,” he said. “Market participants appear to be pricing in price increases of perhaps seven quarters of a percentage point,” he said. “So if that happens, it could push the average credit card rate up to [more than] 18 percent.”
Rossman said minimum payments don’t change much with those rate hikes, about $1 a month for every quarter percentage point of the average credit card balance, which is just over $5,500, according to credit bureau Experian.
But the policy change should be a wake-up call for borrowers who are already paying dearly to service their outstanding balances. “It almost doesn’t matter if it’s 16 or 17 or 18 percent,” he said. “The big point is that they’re already high.”
Mortgage borrowers will also feel the bottleneck. “Higher mortgage rates will make home buying even more difficult than it already is in the current housing boom,” warned Steve Rick, chief economist at CUNA Mutual Group, in a research note. “It will discourage more Americans from accumulating wealth through real estate,” he said.
“The housing market is always sensitive to changes in interest rates,” said Lawrence Yun, chief economist for the National Association of Realtors. For example, a $300,000 mortgage at 5 percent interest would cost nearly $350 more per month than the same principal borrowed at 3 percent interest.
“These are pretty significant changes, especially for first-time buyers,” he said. “All of a sudden they’re being pushed out of the market.”
Mortgage rates, which reflect the underlying interest rate environment but are not as closely correlated to Fed activity as credit card APRs, have already risen, but so far the increases have not been large enough to contain rising housing costs. The February consumer price index, released last week, showed that housing costs posted their steepest annual increase since 1991.
Yun said higher mortgage costs are particularly difficult for prospective minority homeowners to shoulder. “Many African-American homeowners are essentially first-time buyers. Hispanic shoppers are in a similar situation,” he said. A large portion of these prospective buyers lack the generational wealth or available home equity that can help mitigate rising housing costs.
“In general, rising interest rates would hurt minority households more given the dynamics of who rents and who owns,” Yun said.
Higher interest rates are also impacting small business owners, particularly among the same demographics: groups that have historically struggled to access non-predatory finance.
Della Clark, president and CEO of The Enterprise Center, a resource organization for minority entrepreneurs, said owners who are already operating on tight budgets and are being battered by rising costs across the board have little buffer against rising interest rates.
“The majority of American entrepreneurs come from low-income communities, which means … they have little cash reserves to run their businesses,” she said. A 2019 report by the Federal Reserve Bank of Atlanta found that a lack of opportunities to obtain affordable credit is a key reason for the minority-owned small business experience, which it describes as “lower profits and higher death rates.”
“This is where the race and equity gap in capital plays a significant role in the ability of these small businesses to stay in business and thrive,” Clark said. “The cost of money — the cost of capital — is very important to them.”
Rossman said consumers and small business owners should view the next few months as a closing window to secure favorable terms and pay down high-yielding debt before interest rates start to rise seriously. Borrowers with good credit and financial discipline could potentially free up more money to pay off their outstanding balances by applying for a credit card with low-interest or zero-interest balance transfer promotional periods, he said.
If the Fed makes seven rate hikes this year, people with debt might find their dollars don’t stretch as far as they used to. For the average credit card balance, a fed funds rate of 1.75 percent, as opposed to zero, would add another four months to the payout period for a minimum-paying borrower and add an additional $732 in interest.
“It’s just a good reminder to clear those balances,” Rossman said.