Your debt may cost you more if the Fed hikes rates. Just where and when is the question. June 29, 2004: 10:07 AM EDT
By Jeanne Sahadi, CNN/Money senior writer
NEW YORK (CNN/Money) – Let's assume everyone's right and the members of the Federal Open Market Committee on Wednesday will hike the Fed funds rate, the overnight lending rate between banks.
You're probably expecting to feel a pinch, since a Fed rate hike can influence a host of interest rates consumers pay.
But just when that pinch will affect your wallet -- and how painful it will be -- depends on the type of debt you're carrying or hoping to finance. In some instances, the pain actually may be muted or nonexistent.
Mortgages: Mortgages are not directly tied to the Fed funds rate. They tend to track movements in the yields on various U.S. Treasurys and other indexes, which tend to price in anticipated rate hikes.
As a result, mortgage rates – particularly those with very short-term fixed rates, such as three- or six-month adjustable rate mortgages (ARMs) or interest-only loans -- have already begun their climb past record lows.
So if you have a mortgage with a very short-term fixed rate, it's likely your payment has already been affected. Take the 1-month ARM. If you got one in February, you would have paid $734.12 on a $200,000 loan at 1.95 percent. By June, your rate would have jumped to 4.58 percent and your monthly payment would be $1,019.92
If, on the other hand, you have a 10-year or 30-year fixed-rate mortgage or a 5/1 or 7/1 ARM (in which you've locked in a rate for five or seven years), a Fed rate hike won't affect you in the near term.
"The longer the fixed rate, the more insulated you'll be," said Keith Gumbinger, vice president of mortgage information provider HSH Associates.
Interestingly, if you have a 3/1 or a 5/1 ARM that's coming due for adjustment and you never refinanced it, Gumbinger said, you may actually see your payments fall. Here's why: rates for 3/1 and 5/1 ARMs were actually higher several years ago than they are now.
If you've been shopping for a new mortgage – fixed or adjustable – you've already seen a rise in rates. Say you started the hunt in March. You could have gotten a $200,000 30-year fixed rate mortgage at 5.55 percent for a monthly payment of $1,141.84. Today, that same mortgage would garner a rate of 6.42 percent and cost you $1,253.62 per month, Gumbinger said.
Rates for fixed and adjustable mortgages are likely to continue climbing if the bond market anticipates more rate hikes in the offing later this year.
Home equity lines of credit (HELOCs): Most HELOCs have adjustable rates tied to the prime rate. So if you're shopping for one, you'll see rates rise almost immediately when the Fed hikes its rate, but the extra cost to you may not be onerous.
Say the Fed funds rate goes up 25 basis points (or a quarter of a percentage point). The monthly payment on a $30,000 HELOC will go up about $4, Gumbinger said.
If you already have a HELOC, you'll probably have at least one billing cycle before you feel any effect, Gumbinger said.
And in some cases you may have as long as three billing cycles, if your lender bases its HELOC rates on the prime rate that was in effect 90 days ago.
You may not feel the effects of a summer rate hike at all if you're already paying a "floor" rate on your HELOC. The "floor" is the base rate below which the lender will not go.
Since rates fell so far in the past few years, some HELOCs have been sitting at their floors, according to Gumbinger. So even with a rate hike, the new HELOC rate (equal to the new prime plus a margin the lender sets) may still be less than your floor.
But if you're shopping for one, expect higher rates. That's because a home-equity loan rate is broadly tied to the lender's own cost of funds. A Fed hike means the lender's cost of borrowing from other banks will go up.
"If it costs them more, it'll cost you more," Gumbinger said.
But maybe not much more. Lenders have already begun pricing in a rate hike. In April, you could have gotten a $30,000 HEL at 6.75 percent for $265.47 a month. If you got one now, you'd get a 7.05 percent rate and pay an additional $5 a month.
Credit cards: If you have a variable rate card, your rate is determined by a formula tied to the prime rate, which is the rate at which banks lend to their most creditworthy customers. The prime rate tends to move up when the Fed funds rate does.
That doesn't mean your credit card rate will right away.
Credit Card Rates
Find the best credit card for you among thousands of issuing banks.
Select a card type from the pulldown menu and click on the arrow to begin.
Assuming the Fed hikes rates on Wednesday, you're likely to see an increase in rates by the end of summer, said Robert McKinley, founder of CardWeb.com, in an email exchange.
He estimates that a 25-basis-point hike (a quarter of a percentage point) will translate to a 25.5 basis point hike in card rates due to daily compounding. That's an extra $25.50 a year in interest assuming a constant $10,000 balance.
If the hike comes after July 1, "then it will slow down the rate pass-through until the fourth quarter for some variable-rate cards," McKinley said.
Those with fixed-rate cards – which account for nearly 60 percent of all cards -- shouldn't be fooled by the word "fixed." Issuers can change the rate or switch the structure from fixed to variable so long as it gives at least 15 days notice.
They typically don't do this unless they anticipate a rate hike of at least 50 basis points, McKinley noted. "Based on what we have seen so far, we expect issuers will accelerate the migration back to variable rates so they can easily pass on the rate hikes."
So pay attention to any notices you may get (or already have gotten) from your credit card company.
Car loans: Car loans are fixed-rate products. So if you already have one, don't worry about what the Fed does.
36 month new
48 month new
60 month new
72 month new
36 month used
But if you need a car loan, you'll see rates have already begun to climb.
Car-financing rates are not tied to the Fed funds rate. Rather, movement in the yields on the 2-year Treasury is a benchmark, said Brian Reed, a vice president at Capital One Auto Finance. Traders have already priced in a Fed rate hike of 25 basis points, and consequently the rate on the 2-year risen 128 basis points between March 24 and June 23..
But car lending rates haven't risen as much because auto financing companies don't change their rates in lock-step with the somewhat volatile benchmark.
Say you got a $25,000, 60-month loan at 3.85 percent in March from Capital One. That would cost you $458.72 a month. If you got the same loan on June 23, your rate would have jumped to 4.49 percent for a monthly payment of $465.91, a difference of about $7.
Student loans: This is one area you may actually see your rates go down for the 12-month period starting July 1.
That's because student loan rates are not tied directly to the Fed funds rate, but rather to the last auction in May of the 91-day Treasury bill. The rate for that T-bill fell relative to where it was during the same auction a year earlier.
As a result, interest rates for federally guaranteed, variable-rate student loans issued after July 1,1998, will drop 0.05 percent.
The drop is small -- it potentially would save you only about $56 over the life of a $20,000 loan assuming you could lock in that rate. But given that student loan rates have been at all-time lows for a few years, you've had the opporunity to save plenty.
To see whether it makes sense for you to lock in the new rates by consolidating your loans, click here.
Editor's note: This article, originally published in May, has been updated.