For months and months, inflation has been rampant. And consumers have struggled to pay for basic necessities, such as gasoline, groceries and utilities. The problem has gotten so bad that many people are running out of their savings and piling up credit card debt just to stay afloat.
Meanwhile, the Federal Reserve has just taken an important step to fight inflation: it has raised interest rates by three-quarters of a percentage point. This is the largest rate hike since 1994. This means that the loans are about to get much more expensive.
Consumers need to be prepared to pay
Let's get one thing straight: the Fed doesn't set interest rates for consumers. When we talk about rate hikes, we are referring to the federal funds rate, which is the rate that banks ask each other for short-term loans.
But when the federal funds rate goes up, consumer interest rates tend to follow. And this can be both good and bad.
Consumers who own savings accounts can benefit from higher interest rates. But those wishing to borrow money may be forced to pay more in the form of higher mortgage rates, personal loan rates, and so on.
Rising interest rates can also pose problems for those with variable interest rate debt. This means that consumers with credit card and HELOC balances could see their interest rates rise.
Will rate hikes bring inflation down?
The reason why the cost of living has risen so much right now is that the supply of available goods has not been sufficient to meet the demand of the buyers. This is because unemployment levels have been low for some time, and thanks to steady earnings and residual stimulus funds, consumers have had more money to spend.
If lending rates rise, consumers could start spending less. This could help supply match demand. And when that happens, prices should start to go down.
Now, if consumer spending falls to a certain point, it could trigger a recession. And this is not ideal. For this reason, the Fed's drastic rise in interest rates is considered by some to be too extreme. But given the surge in inflation, it is also easy to argue that this is a necessary measure.
According to the Department of Labor, the consumer price index rose 8,6% year-on-year in May. It is a level of inflation that the Fed cannot ignore. And rising interest rates are truly the only weapon in his arsenal to help what has become a major crisis for everyday consumers.
Waiting could mean being forced to pay more interest!
However, we can take steps to avoid being hurt by the rate hike. If you have a credit card balance, for example, you should aim to pay it off as soon as possible. Waiting could mean being forced to pay more interest. Likewise, anyone looking to lock in a fixed-rate mortgage should move as soon as possible, before interest rates start to rise.
Borrowers with adjustable rate mortgages may also want to consider a refinance to switch to a fixed rate mortgage. Sure, mortgage rates are high right now across the board, but at least this way borrowers know what rate they are getting.