Why U.S. Banks Are Hiking Their Rates

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KEY POINTS

  • The federal funds rate is the rate at which banks and credit unions borrow from and lend to each other.
  • The Federal Reserve has raised interest rates five times this year to deal with high inflation.
  • Banks pass on the higher borrowing costs to consumers but also raise rates on savings accounts.

Average interest rates on savings accounts have tripled in one year.

You may have noticed that it costs more to borrow money right now than it has in the recent past. You might also be earning more money in your savings account these days. This is because major U.S. banks have been steadily increasing their interest rates over the last few months.

The Federal Reserve interest rate, also known as the federal funds rate, is the rate at which banks and credit unions borrow from and lend to each other. It's determined by the Federal Reserve and can be changed at any time. These changes can impact consumers because the Federal Reserve interest rate tends to influence interest rates on credit cards, loans, and savings accounts.

If you're wondering what this means for you, you're not alone. Here's how the federal funds rate has changed recently and how it could be affecting you.

Five rate hikes this year

The federal funds rate is 3% to 3.25% as of Sept. 21, 2022. This is the third consecutive rate hike of 0.75% -- and the fifth rate hike this year. It's also one of the largest increases in decades as the Fed focuses on fighting inflation levels that are at 40-year highs.

According to a recent statement from the Fed, the organization's goal in raising interest rates is to return inflation to 2%. During the pandemic, inflation hit close to 0%. But that number quickly rose, reaching 5.4% one year ago and peaking at 9.1% in June 2022. Even with the Fed's rate hikes, inflation only dropped to 8.3% in August.

How rate changes impact you

In response to the rate hikes by the Fed, banks have also raised interest rates. Credit cards and savings accounts are most sensitive to changes in the federal funds rate, followed by personal loans and auto loans, and finally, mortgage loans.

Here's how banks set the interest rates on its products, and how changes in the federal funds rate might affect you.

Credit card interest rates

Most credit cards have a variable interest rate, so a change in the Fed’s benchmark will directly impact a credit card’s annual percentage rate (APR). This is directly tied to the prime rate, which is the interest rate for customers with prime credit, and it's pegged at 3% above the upper limit of the federal funds rate.

What's more, since credit cards are a short-term borrowing method, their rates tend to update almost immediately in response to federal funds rate changes. As of this writing, the average credit card interest rate was 18.44%, according to data from CreditCards.com. And the average subprime credit card APR was at 27.12%. And with recent interest rate hikes, many credit cards interest rates have hit record highs.

All these numbers translate to higher interest rates for consumers. So now is a good time to pay extra close attention to the variable rate on your existing credit cards -- and keep an eye on the rates of new cards if you're in the market for one.

Personal loan interest rates

Interest rates on personal loans aren't directly tied to the federal funds rate, but they can be influenced by it. Plus, loans with variable interest rates can fluctuate as the federal funds rate changes. For example, the average interest rate for a 24-month personal loan was 8.73% in May 2022 (the latest data available), according to the Federal Reserve.

If you are shopping for a personal loan, be sure to consider how the interest rate could change over time, as well as what rate you're getting going in.

Savings account interest rates

Interest rates on savings accounts are fairly responsive to changes in the federal funds rate. The current APY for savings accounts is now at 0.17%, almost triple the APY of 0.06% from earlier this year, according to data from the FDIC. Many CD rates have also gone up since the Fed's rate hikes.

If you have a savings account, you may have seen your interest rate go up once, or even multiple times this year, and that's likely a direct result of the changing federal funds rate.

As mentioned, banks have raised interest rates on these accounts as the Federal Reserve gradually raised its own benchmark interest rate over the past year. As a result, banks have passed on the higher borrowing costs to consumers -- and also raised rates on savings accounts. So if you're in the market for a new banking product, or just keeping tabs on your existing accounts and loans, be sure to have an eye on the federal funds rate to see how it affects your bottom line.

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