How Does an Interest Rate Increase Impact Consumers?

Jan 18, 2019

Rising interest rates

In December 2018, the Federal Reserve raised the federal funds rate in the fourth increase of the year. As the most significant interest rate benchmark in the country, it’s common knowledge that the federal funds rate impacts the cost of borrowing money. But the extent to which it affects our money and our financial choices depend on various factors that are, in some cases, easily misconstrued. Here’s what to know about the federal funds rate in order to make more informed decisions about money in 2019:

A brief background: At a basic level, the federal funds rate is that which financial institutions charge each other to borrow money on an overnight basis when reserves dip below amounts required by law. But it’s also much more than that. Importantly, it’s a means by which the government adjusts  the supply of money in the economy to achieve maximum employment levels and stable prices. If financial growth is slowing, the Fed will lower the federal funds rate in order to expand the supply of money— making it cheaper to borrow. When growth increases to levels that appear unsustainable, the government will then increase the fed funds rate to keep inflation in check and cool off an overheated economy.

The wavelike effect of interest rates: In general, adjustments in the federal funds rate are passed on to both consumers and businesses seeking access to credit based on the U.S. dollar, either directly or indirectly. Essentially, a hike in interest rates means people often pay more for the money they borrow. After the Fed announces a rate increase, banks and credit unions typically announce a similar increase in what is referred to as the prime rate.

The prime rate benchmark: Simply put, the prime rate is the interest rate which financial institutions extend to their most qualified applicants, and it’s the rate at which several forms of short-term consumer interest rates are based. Typical interest rates that are directly connected to the prime rate include adjustable-rate mortgages, credit cards and home equity lines of credit (HELOCs) with adjustable rates. Rates for these products are usually established by taking the prime rate and adding a certain percentage point to it. When the prime rate goes up, so do these short-term consumer interest rates.

The Motley Fool offers an easily digestible formula for how the prime rate correlates to the interest rate of a credit card. For instance, a credit card contract might list a cardholder’s interest rate as “Prime Rate [plus] 12.49%. When the prime rate is set at 4 percent, the account holder would pay an interest rate of 16.49%  (4.00% +12.49%).%). But if the prime rate climbs to 4.75%, the same cardholder would pay an additional .75% in interest for a 17.24% APR (4.75 % +12.49 %).

A breakdown of how rising interest rates may impact various areas of your financial life:

Credit cards: As a financial product tied to the prime rate, you can expect your APR to rise around the time of your next billing cycle following an announced increase. To continue to get the lowest interest rates possible, take care to improve or maintain your credit score by making on-time payments, keeping your credit utilization low (ratio of your credit card balances to your credit limits) and following advice in our article “How to Improve Your Credit Score Using Your Credit Cards.” Among the recommended strategies you’ll find here is to transfer high-interest credit card debt to a card with better terms.

Auto loans: If you’re concerned that the interest rate hike might mean you’ll have to allocate a much larger share of your budget to a new vehicle in the upcoming months, it may be reassuring to hear that this is likely not the case. As CNBC points out, the amount of interest you pay on your car loan will be much more heavily dependent on your credit score and the lender you choose.

Home loans: If you have an adjustable-rate mortgage (ARM), your interest rate is tied directly to the prime rate, and you can expect to realize an increase at the next adjustment period. A home equity line of credit (HELOC) with an adjustable rate will also shift upward in the next billing cycle.

Fixed-rate mortgages aren’t directly correlated to the prime rate benchmark. Instead, they’re tied to the yields on U.S. Treasury notes. As such, a change in the fed funds rate has a less immediate effect on fixed mortgage rates. However, new offers for these loans will eventually inch up as banks and credit unions must pay more to borrow money from other financial institutions in order to manage their cash flow.

Savings: Following a federal interest rate hike, financial institutions are generally slower to increase rates on savings products than they are to raise them on loans and lines of credit. However, interest rate adjustments tend to eventually impact deposit accounts as well, allowing savers to earn higher yields from their hard-earned dollars. At SFPCU, we’re already out ahead of the game—acting quickly in response to the Federal Reserve’s latest move to ensure that our members receive a competitive interest rate on their savings. On December 20, 2018, we raised rates on our Certificates, quickly followed by an increase on our Tiered Savings and Money Market Account rates on January 1, 2019. For an incentive to get yourself on the right financial track now, find details at

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APR = "Annual Percentage Rate". Actual APR is based on your credit profile and may be higher than the lowest rate available. Posted rates may include promotional discounts and other terms and conditions. APY = "Annual Percentage Yield". Rates are subject to change without notice.

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