The Fed And Your Finances

Many consumers may be panicking at the interest rate increases set in motion with today's rate hike by the Federal Reserve.

Yet the Fed has said it will raise the federal funds rate — which serves as the benchmark for all other interest rates — at a "measured" pace. And the impact of higher rates may be further muted because rates are starting from such a low point.

Now, the federal funds rate is at 1.25 percent, still its lowest level in decades. But longer-term, interest rates are forecasted to increase to 2.25 percent by the end of 2004 and 3.75 percent by year-end 2005.

Changes in interest rates can affect the overall economy, with higher interest rates being considered "bearish," while lower interest rates are "bullish."

Essentially, higher interest rates tend to slow economic activity as they raise borrowing costs for consumers and businesses, while lower interest rates stimulate economic activity.

Either way, interest rates influence the sales environment. In the consumer sector, the rate at which homes or cars are purchased tends to slow as interest rates rise. For businesses, particularly those with high debt loads or those which have to finance high inventory levels, interest rates are a significant factor as the interest cost has a direct impact on corporate profits.

Interest Rate Impact

With the Fed having raised interest rates, the impact on consumer loans will vary. Many consumer loans have already accounted for the rate increase. For the consumer, this means rates for car loans, mortgages and home equity products are on the way up.

On mortgages: Mortgage follow yields various U.S. Treasuries and other indexes, which usually price in anticipated rate increases. As such, mortgage rates have already begun to rise. The shorter the term of your loan, such as those with short-term adjustable rates, the more quickly your interest rate will be affected.

Where are rates now? As of June 23, the average 30-year fixed-rate mortgage dipped from 6.35 percent to 6.3 percent, while the 15-year fixed-rate mortgage fell from 5.75 percent to 5.72 percent and the jumbo 30-year fixed-rate mortgage dropped from 6.53 percent to 6.5 percent. The average one-year adjustable-rate mortgage declined for the first time in three weeks, from 4.37 percent to 4.36 percent. Although rates recently dropped a bit, they will likely begin to climb again if the bond market forecasts more rate increases later his year.

On car loans: Interest rates on car loans are linked to movement in the yields on the 2-year Treasury, which has already priced in the anticipated federal funds rate hike. So, those looking to buy a new car may have already seen increases in car loan interest rates. However, if you already have a car loan, no need to worry as your rate is fixed.

Where are rates now? As of June 23, the average rate for four-year and five-year new-car loans increased to 7.43 percent and 7.46 percent, respectively. The average rate for three-year new-car loans was unchanged at 7.4 percent, but is still up from 7.16 percent at the end of March. The average three-year used-car loan rate was unchanged at 8.46 percent.

On certificates of deposit (CDs): Yields on CDs will be impacted by a rise in the federal funds rate. When investors command higher returns for investing in Treasury securities, banks are compelled to increase yields on CDs to retain and attract customers.

Where are rates now? Yields CDs of all sizes have been increasing in recent weeks leading up to the expected interest rate hike by the FOMC. As of June 23, the average one-year CD yield increased from 1.43 percent to 1.48 percent. The average yield on a jumbo CD of $100,000+ jumped from 1.58 percent to 1.64 percent. Expectations for continued interest rate increases in August and beyond will buoy yields on longer-term CDs (i.e., those with maturities longer than one year).

On home equity loans and lines of credit: Home equity loan rates will be impacted by the Fed's action as a rate increase means it costs more to borrow money. Because the prime rate changes within a day or two of a Fed cut, many new home equity loan customers will start seeing higher rates shortly thereafter. Existing borrowers, however, will not feel an impact as equity loans have fixed payments and rates. In terms of equity lines of credit, most feature variable rates and payments are tied to the prime rate.

Where are rates now? As of June 23, the average home equity line of credit (HELOC) rate dropped 1 basis point to 4.77 percent (a basis point is one 1/100th of a percentage point). The average fixed-rate home equity loan was unchanged at 7.22 percent. Home equity products are sensitive to interest rate increases by the Federal Reserve, with new borrowers noticing the difference on fixed-rate home equity loans. Both new and existing HELOC borrowers will feel the effects of increasing rates as the variable rate HELOC follows the prime rate.

On credit cards: Credit card users will be impacted by a Fed rate increase. However, when you will actually see the interest rate change on your credit card statement depends on when it is re-priced-some re-price each quarter while others re-price each month. If you have a fixed-rate credit card, you are not necessarily insulated from rate fluctuations. In fact, issuers can change rates or change the card to a variable-rate with as little as 15 days' notice.

Where are rates now? As of June 23, the average standard fixed-rate card dropped to a new low of 12.79 percent, while the average platinum fixed-rate card declined to a five-year low of 11.97 percent. Both moves were precipitated by juggling offers at local banks that use the same large issuer. These declines may be short-lived though as fixed-rate credit cards will not be shielded from rising interest rates. There were no rate changes in any of the variable-rate classes or in the gold fixed-rate category.

On student loans: Student loan rates are linked to the last auction in May of the 91-day Treasury bill, which dropped relative to where it was during the same auction the prior year. This means that rates on student loans will actually decrease for the 12-month period beginning July 1, 2004. Specifically, interest rates for federally guaranteed, variable rate student loans issued after July 1, 1998 will drop .05 percent.

Where are rates now? On July 1, 2003, the interest rate on Stafford loans — the largest source of student loan funds in the country-dropped to 3.42 percent from a then-record low of 4.06 percent.

E-mail Mellody with your personal finance questions.

Mellody Hobson, president of Ariel Capital Management ( in Chicago, is Good Morning America's personal finance expert. Ariel associates Matthew Yale and Aimee Daley contributed to this report.