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Your Money

Planning Your Future

What Fed Rate Increases May Mean for Your Finances

It's finally arrived. The Central Bank has signed off on its first rate hike in seven years. As anticipated, the Federal Reserve raised the short-term Fed Funds rate, which is the interest rate at which banks borrow from one another overnight, by 25 basis points to roughly 0.25%.While the increase is small, economists forecast rates will continue to gradually climb over the next two years.

Make the most of your money.

If that proves true, we can eventually expect to see rates rise across many financial products, particularly those with short-term variable interest rates like credit cards. While this may make some borrowing costs more expensive, the Fed's decision to boost interest rates is actually a result of our growing, strengthening economy. And that's good news.

Here's what the Fed latest move means for your finances.

Credit Card Rates May Tick Slightly Higher

The Fed Funds rate directly impacts the so-called "prime rate," a factor used to calculate the annual percentage rate (or APR) on variable interest credit cards. The APR is typically the sum of an index (often the prime rate) plus a margin. The average APR on a credit card ranges from 11.66% to 15.26%, depending on the type of card, according to Bankrate.com.

If you have a variable rate card, you might see your APR rise by a fraction in the coming weeks. Even so, you may not really feel the increase, especially if you keep your card balance somewhat low. A $1,000 card balance, for example, will only experience about a $2.50 gain in interest. And, of course, this will not impact you if you pay your statement in full each billing cycle.

Your Savings May Sweeten

For years, most savings accounts have earned – at best – one percent, often just a fraction of a percent. But a growing Fed Funds rate usually contributes to a higher savings rate, offering us a nicer incentive to spend less and park our cash in savings accounts, CDs and money market accounts. That's actually what the Fed hopes we'll do, as a spending slowdown can help to keep inflation under control.

It's not certain how fast banks will raise their savings rates after this announcement. As the Wall Street Journal recently reported, lenders aren't experiencing as great a need to lure in deposits, thanks to strong liquidity already in the marketplace. The average personal savings rate in the U.S. is currently 5.6%, compared to 2.8% ten years ago, according to the most recent U.S. Department of Commerce Bureau of Economic Analysis report.

If you've yet to begin preparing for a rainy day, let this interest rate news serve as an important catalyst to start a savings plan. Ideally you want to have between six to nine months of your basic living expenses reserved in an FDIC-insured savings account.

Mortgage Rates Won't Jump…At Least Not Right Away

While interest rates on fixed-rate home loans do not correlate directly with the federal funds rate, there is sometimes an eventual trickling effect.

There are many factors that influence 15- and 30-year mortgage rates, including economic growth, inflation and the 10-year Treasury note (which sometimes moves in tandem with the fed funds rate, but not always.)

The exception here is an adjustable rate mortgage (or ARM). In that case you may see your rate increase at the next payment period, as it often follows the one-year Treasury index, which correlates with movements in the Fed Funds rate. Keep in mind that if you're in the market for a home loan, borrowers with strong credit have a better chance of securing the lowest interest rates. According to FICO the lowest mortgage rates currently go to borrowers with credit scores of 760 or higher.

Some Student Loans Won't Be Impacted

If you're paying down a federal student loan that stems from 2006 or later, no need to panic. Your loan carries a fixed interest rate for life, so movements in the Fed Funds rate bear no influence.

For pre-2006 federal student loans, the rate is most likely variable and a Fed Funds rate increase may bump your rate up the next time it resets – usually once every year in May. Contact your loan officer to confirm.

For prospective federal loan borrowers, the government (since 2010) pegs the interest rate to the 10-year Treasury note, so again, a Fed rate increase won't have a direct impact.

As for private student loans, fixed rate loans, again, won't be affected. But a large number of private loans have variable rates, which may cause the rate to nudge higher in the approaching months.Remember: Most lenders – public and private – will provide an interest rate deduction(usually a quarter of a percent) when borrowers automate their bill payment. For some,this could be one quick way to offset the recent rate increase.

Infographic: Prime Rate Primer

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