What the Fed decision means for you

For months mortgage rates have shot up while the Fed has slashed interest rates. What's going to happen now?

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By Jessica Dickler, CNNMoney.com staff writer

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NEW YORK (CNNMoney.com) -- If you have a mortgage, carry credit cards and are considering a home equity loan to cope with soaring food and energy prices, you should be paying attention to what the Fed has to say.

On Wednesday, the Federal Reserve held a key short-term interest rate steady, following a series of steady rates cuts - a move that signals to some that rates are about to change direction. And most assume that means consumer lending rates will rise as well.

But the central bank had cut rates seven times since September in an effort to bolster the lagging economy and spur economic growth. And during that time, mortgage rates were increasing. So what gives? And what should consumers expect loan rates to do next?

How it works

The fed funds rate is often thought of as a benchmark to set rates paid by consumers on many types of loans, from mortgages and home equity lines of credit to credit cards and business loans.

Generally, the Fed lowers rates when it is concerned about the economy slowing and raises rates when it is more worried about inflation. In times of lower interest rates, consumers tend to spend more because of the cheap cost of borrowing.

But people incorrectly equate the Federal Reserve's actions with changes in consumer interest rates, cautioned Eric Tyson, author of "Personal Finance for Dummies."

There is not a direct connection, he explained, but an indirect one. "Rates are set by market forces and they have been trending higher in part because of inflationary concerns and, in part, because of Fed expectations." So with inflation fears on the rise and many investors expecting the Fed to raise rates again, mortgage rates have already begun to tick higher.

Rates on 30-year fixed mortgages have surged to a 9-month high on growing concerns about inflation, according to a recent report by mortgage backer Freddie Mac.

And rather than track the fed funds rate, which is the rate banks charge one another for overnight loans, fixed mortgage rates are more closely aligned with the yield on the 10-year treasury note, which offers a long-term look at a fixed investment.

While the lagging economy has bolstered the yield on the benchmark 10-year note, it still remains at a relatively low level, Tyson said.

Unlike fixed-rate mortgages, adjustable-rate mortgages can fluctuate in response to a number of rates, depending on the terms of the loan. Many are pegged to the Libor rate, an international interbank lending rate. Others follow the prime rate, which is generally three percentage points higher than the federal funds rate (presently the prime rate is 5%).

Credit card companies also tend to move the rates on their variable rate credit cards in line with the prime rate of interest.

"Credit cards are generally tied to the prime rate which usually moves in lock step with the Fed's actions," according to Scott Hoyt, senior director of consumer economics at Moody's Economy.com.

Why it matters

Even as the Fed leaves rates unchanged, what they say about the economic picture could also influence consumer interest rates in one direction or another.

"Most likely they will express concern about inflation," said Keith Gumbinger, vice president of HSHAssociates.com, an online publisher of consumer loan information, which could send consumer interest rates higher as people take that as a cue that the Fed intends to start raising rates soon.

So if you are in the market for a house, now could be the time to pull the trigger before rates rise even further. As Tyson points out, yields on 10-year treasury notes are still relatively low, an indication that 30-year mortgages could still be a good deal.

Financing conditions for lines of credit, including home-equity lines, will be tighter than they have been for years. "Keep in mind that it will be difficult to leverage your home's value to greater than 90%," Gumbinger said. So if you do need to borrow against your home equity, now might be a better time than in the near-term future.

And it is likely that credit card issuers will switch back to variable interest rates to ride the future rate hikes, according to Robert McKinley, CEO of credit-card tracker CardWeb.com.

"Consumers should be weighing carefully all card offers they receive in the mail or via the Internet to lock in a good promotional rate or long-term rate, before rates head north again," McKinley advised.

If you carry a balance on your credit card, now is a good time to pay that down as well. But generally speaking, "if you have consumer debt you should get rid of that anyway," Tyson said.

But since no one can predict for certain what the economy will do, and how the Fed will react, it is generally not a wise idea to make critical financial decisions based on expectations about what will happen with interest rates, he added.
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