No one will know until we all know, but most analysts agree and investors are betting that the “Feds” – the Board of Governors of the Federal Reserve Bank – will raise interest rates when they meet on December 15th and 16th. How will this impact you?
First, let’s talk about what interest rates they control, and just as importantly what interest rates they do not control.
The Feds control only two rates: the Discount Rate, and the Target, or Overnight Rate.
The Discount Rate is the rate at which the Federal Reserve lends money to banks for short-term needs to meet liquidity requirements. Banks cannot lend out every last penny in their vault, because they would be at risk of not being able to pay depositors back if many of them wanted to withdraw money at the same time. They have to keep a certain amount of money liquid and available for depositors.
When a bank has a very good month lending, they might be short on reserves. If so, they can borrow money from the Feds for a very short time at the current Discount Rate in order to have the minimum required reserves available. What is that rate today? 0.00%. That is correct, banks can borrow money from the Fed (if they are short on reserves) for free.
The Overnight Rate is not technically set by the Feds, but the Target Rate is. The Feds establish a target interest rate for banks to lend to each other for overnight needs for the same challenge – a shortage of reserves. The target rate today is 0.25%. It is infinitely higher than the Discount Rate, but still not a bad deal.
Notice that in this discussion mortgage rates are missing.
These are the only two things that the Feds can directly control. Most analysts agree that in December the Feds will raise the Discount Rate, which will naturally increase the cost of short-term borrowing by banks. The projected increase is 0.25%.
How will this impact you? Any interest rates that must reflect the short-term cost of funds for banks will have to increase by the same amount. The two types of loans that fall into this category would be equity lines and credit cards – both types of lending meant to be short-term.
The most commonly-recognized index for both types of cards is the Prime Rate. This is the interest rate that banks charge their most credit-worthy corporate clients, but it is also the index that almost all equity lines (including Home Equity Lines of Credit and Business Lines) and credit cards are tied to.
The most immediate impact that you will see, therefore, is the Prime Rate will increase by the same amount the Feds increase the Discount Rate and the interest rate on your equity line and credit cards will increase by the same amount too.
The interest rates on car loans are also likely to increase a little, because they are short-ish in term. However, if you already have one chances are it’s a fixed rate, and the interest rates for car loans written after December are likely to come back down over time due to competition.
If you want a general rule of thumb to figure out whether in interest rate will increase or not, here it is: If the loan is meant to be short-term and is made from the bank’s own deposits, then the interest rate is likely to go up.
Mortgage rates are not short-term, and while they are funded from the bank’s deposits (in most cases) they are immediately sold to Fannie Mae, Freddie Mac, or Wall Street investment bankers who create large funds to invest in mortgages. Since it is not their own money they are lending, the short-term cost of funds to the bank have no impact on mortgage rates.
Having said that, the Feds can influence mortgage rates through the purchase of Mortgage-Backed Securities using money borrowed from the U.S. Treasury. I covered the use of Quantitative Easing back in June in this article: How Quantitative Easing Affects Mortgage Rates
But for now, watch for an announcement from the Feds on December 16th.