Since the financial crisis more than a decade ago, interest rates have reached historic lows. But with inflation returning for the first time in four decades, the Federal Reserve has indicated that rates will likely go back up, at least for a while.
Wrapping up a two-day meeting of the Fed’s Open Market Committee, a majority of its members predict that there will be three increases in the Fed’s key interest rate in 2022.
So, what does that mean for consumers? The biggest impact will most likely be on credit card rates, which are most directly connected to the federal funds rate and used to control the amount of cash in the monetary system. Over time, however, the ripple effect could make all types of borrowing more costly.
The Fed’s rate hikes are likely to be small. Normally, the Fed raises its rate a quarter-point at a time. Since the current rate target is near 0%, the federal funds rate is likely to be 1% or less at the end of the tightening cycle next year.
By raising interest rates, the Fed hopes to slow inflation by slowing business activity. Sara Rathner, credit cards expert at NerdWallet, says inflation makes everyday purchases more expensive, raising the risk that consumers will increase high-interest credit card balances to meet everyday expenses.
“This is especially difficult for those who lost income during the pandemic and are struggling to make up lost ground,” Rathner said in an email to ConsumerAffairs. “While an increase in interest rates would make credit card debt more expensive, interest rates are always high for these products.”
Mortgages, and some other longer-term loans, are not directly tied to Federal Reserve interest rates but to U.S. Treasury bonds. If rising rates cause the economy to slow, more investors may purchase these bonds, causing those rates to go down. That could keep mortgage rates low.
For the housing market to remain stable, mortgage rates must remain close to where they are now. With home prices at record highs, any increase in mortgage rates will make monthly payments less affordable.
If all types of interest rates rise to levels that were prevalent before the financial crisis, economists warn that sectors of the economy that are dependent on financing – such as housing and the auto industry – would suffer because fewer consumers could afford the monthly payments.