Bad Credit

The Fed just gave bad news to people in debt

Image source: Getty Images

Rising rates could affect your current debt costs and your ability to refinance.


Key points

  • The Federal Reserve announced a rate hike of half a percentage point on Wednesday, May 4, 2022.
  • The benchmark rate went from nearly 0% during the pandemic to between 0.75% and 1.00%.
  • If you owe money, that’s bad news since you can expect borrowing costs to increase.

On Wednesday, May 4, 2022, the Federal Reserve announced the second increase in its benchmark interest rate since 2018.

The Fed first raised rates in mid-March 2022, in an effort to address soaring inflation, but rates only rose 25 basis points. Now a much larger rate increase has been announced – the largest since 2000. Rates have risen by 50 basis points, leading to a half-percentage increase and bringing the benchmark rate down to between 0.75% and 1.00%.

Since rates were close to 0% during the pandemic, this is a huge rate increase. And if you’re currently in debt, that could be really bad news for several key reasons.

Credit card interest rates will increase

If you have a balance on your credit cards, you must pay interest on the amount you owe. Interest rates are usually variable on credit cards. This means that you are not guaranteed to be able to continue paying the same rate over time. Instead, your rate is linked to a financial index which is affected by the federal funds rate.

A large increase in this rate, such as the one that occurred today, causes your card issuer to increase the rate they charge you. You’ll see a higher rate go into effect within a billing cycle or two, which will drive up your borrowing costs.

If you can pay off your card balance in full, you can avoid being hit with additional interest charges once your rates go up. If this is not within your financial reach, a balance transfer could help if you qualify.

Balance transfer cards charge you a small fee – usually around 3% – to move an existing balance from one or more credit cards. The transferred balance is subject to a 0% interest rate for a fixed period of 12 to 15 months. Therefore, paying an affordable upfront fee could keep your interest rate down to 0% for a long time, so you won’t have to worry about your rate going up in the short term.

Adjustable-rate mortgages could become more expensive

If you have a fixed rate mortgage, the Fed rate hike will not affect you. But if you have an adjustable rate loan, that’s another story.

You see, ARMs allow you to lock in your starting rate for a period of time – usually three, five or seven years depending on whether you have a 3/1 ARM, 5/1 ARM or 7/1 ARM. After the expiry of this initial period, your rate evolves with a financial index. And therefore, rising interest rates will likely drive up your mortgage costs.

When your rate increases, your monthly payment may also increase in order to repay your loan on time. And your total borrowing costs over the life of a loan will be higher since you send more money to your lender.

Unfortunately, there’s not much you can do if you have an ARM. Your rate will almost certainly go up if it is already in the adjusting phase or if it will be soon. You may want to consider refinancing a fixed rate mortgage so that you have more certainty in the future about how much you will pay.

The big downside is that refinance rates have already risen significantly from last year and are expected to rise further with the Fed announcement. Still, it may be worth refinancing as soon as possible to lock in today’s current rates, as the central bank has signaled that more rate hikes are coming.

Refinancing Debt May Not Be Worth It Anymore

As mentioned above, refinancing a mortgage has already become significantly more expensive compared to last year, and refinancing rates are likely to rise further thanks to the Federal Reserve’s efforts to fight inflation.

It’s not just mortgage refinances that could be affected either. If you were hoping to get a personal loan to refinance an existing debt, the rates will likely be higher as well. You’ll need to shop around carefully and compare what you’re currently paying to the rate you’re being offered to decide if refinancing still makes sense for you.

As you can see, this rate increase is not good news if you owe money. But if you’re aware that your rates may go up, you can be proactive in coming up with a plan to try to pay off the debt or minimize the damage in other ways, such as transferring your credit card balance. It’s worth it, especially since interest rates are expected to continue to rise throughout this year.