Protect Your Wallet From the Rising Fed Funds Rate
There’s always a flurry of media attention when the Federal Reserve (the Fed) announces increases to its federal funds rate (commonly known as the “fed” funds rate). Many consumers are left scratching their heads, wondering:
- What does this mean?
- How does it affect my finances?
- What can I do to lessen the impact on my wallet?
We’ve rounded up the details so you can smartly manage your loans.
What is the federal funds rate?
The fed funds rate is the rate that banks and other financial institutions charge each other for short-term loans; these loans are used to maintain their cash reserves, as required by the Federal Reserve.
The Federal Reserve’s policy making panel sets the short-term target interest rate, which it uses as a tool to help drive economic performance. If the economy is sluggish or inflation is too low, they’ll lower the rate; if the economy is overheating or inflation is too high, they’ll raise the rate.
The rate is established by the Federal Open Market Committee (FOMC). So when the FOMC is mentioned in the news, you’ll want to pay attention!
You can learn more about the Fed with this article: How a “Duck Hunt” Led to the Federal Reserve
How does the fed funds rate influence consumer loans?
Banks and lenders often use the fed funds rate to set their prime rates, as it’s directly influencing their cost of doing business. Prime rates are typically used to price variable rate loans, like credit cards and home equity lines of credit (HELOCs). The fed funds rate also influences the 10-year Treasury bond, which is tied to mortgage rates.
What types of loans are affected by fed funds rate increases?
Fed funds rate fluctuations influence a variety of consumer loans, including credit cards, HELOCs, student loans, auto loans, and mortgages.
If you have a fixed-rate loan, your rate is locked in for the life of the loan. However, if you have a variable-rate loan, your rate can change along with the fed funds rate. Most often, you’ll experience this with credit cards and other lines of credit like HELOCs, as well as adjustable-rate mortgages (ARMs).
You can check your loan docs to determine if your loans are affected. If you have an adjustable-rate loan, the docs will explain when and how the rate is adjusted. Look for the index and margin to determine how the rates are calculated.
4 Steps You Can Take to Lessen the Impact of Rate Increases
Here are steps to take when you learn of increases to the fed funds rate.
1. Identify your affected loans
Review your existing loans and credit cards to identify the following and help focus your actions and timeline:
- Which ones have variable rates
- Your existing interest rate
- How rates are calculated (index and margin)
For example, if you have an ARM, you’ll want to know when your rates are set to change and how the new rates will be calculated.
If you aren’t sure of the details, you can call a lender like Axos Bank for perspective on how to calculate the costs and benefits of refinancing.
2. Consolidate existing credit card debt
The potential benefits of a debt consolidation loan include securing a lower interest rate and lowering your overall loan payments. Here’s an article that provides more details: A Personal Loan Can Lift the Weight of Credit Card Debt.
As you research a consolidation loan, take the time to evaluate your other existing debt. You may be able to lower your overall blended rate for your fixed-rate loans as well, which could result in even more savings.
3. Limit new credit card debt
Credit cards are a handy and secure payment tool. But they can be expensive when you carry a larger balance, especially if there are rate increases. Aim to pay your full statement balance each month to avoid interest costs. Then you won’t have to worry about the impact of rate changes.
4. Consider refinancing ARMs, HELOCs, and interest-only mortgages into a fixed-rate option
Here are questions to consider as you make your decision:
- How much time is left on the loan?
- What is the current rate compared to available fixed-rate options?
- How long do you plan to own the property?
If your rate isn’t set to change for several years, it may be appropriate to wait out the current rate increases. But if your mortgage rate is set to adjust in 1 to 2 years, it may be time to refinance to a fixed-rate mortgage. It all comes down to your comfort level with potentially higher monthly payments.
Axos Bank Is Here to Help
There’s a lot to learn when it comes to loans and interest rates. Axos Bank offers an extensive library of educational articles and calculators to help you get started.