How Will a Fed Hike Affect Lending and Credit?

How Will a Fed Hike Affect Lending and Credit?
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Recent comments made by members of the Federal Reserve Board make it pretty clear that a rate hike is in the offing by the end of the first quarter. If that hike goes well, the Fed could implement three more hikes before the year is out. The question is how those potential rate hikes could affect lending and credit.

What we are talking about here is the Federal Reserve increasing its benchmark rate, which is the rate charged when they lend to retail and commercial banks. Lenders and other creditors often base their interest rates off the Fed’s benchmark rate. But that’s not always the case, which is why rate hikes this year could affect different forms of credit in opposite ways.

Getting a Handle on Inflation

So why has the Fed signaled an interest rate hike? The need to get a handle on runaway inflation. At the onset of the housing crash in 2008, the Fed slashed its benchmark rate drastically. As you know, it was near zero for quite some time. Then it began to creep up as the economy recovered.

It was slashed to near zero again when the COVID pandemic hit. The thinking was that slashing interest rates spurs investment and economic activity. But with employment returning to near normal and the economy humming, consumer prices are rising too quickly. This is cause for concern.

Bumping up interest rates will theoretically slow down inflation by making borrowing more unattractive. It is a practice that has been utilized time and again since the Federal Reserve was established.

Interest Rates on Mortgages

In all likelihood, a fed rate increase will lead to higher interest rates on mortgages. That stands to reason, since retail banks will pay higher rates for the privilege of borrowing from the Fed. They will pass those higher rates on to consumers. However, there is a possibility that mortgage rates could remain stable or even fall.

Mortgage rates are often tied to U.S. Treasury Bonds instead of the base rate. Note that Treasury yields fall as inflation rises. This often means that mortgage rates follow. So if Treasury yields do not rebound quickly after a fed rate hike, mortgage rates may stay put for a while.

Hard Money Rates

Interest rates on hard money loans can be set at whatever level lenders choose. Salt Lake City’s Actium Partners explains that lenders typically take the going rate for retail loans and add several percentage points to cover their risk. So if interest rates on most retail loans generally go higher, so will hard money rates. Expect that to be the case in the wake of future Fed hikes.

Credit Cards, Car Loans, Etc.

All the other common forms of credit – think credit cards, car loans, etc. – are likely to see higher rates as a result of a fed hike. Credit card rates may not go up too much, seeing as how they are awfully high to begin with. But definitely expect to see rates on car loans jump.

Bear in mind that most forms of non-secured credit have rates based more on supply and demand than anything else. The same is true for car loans. So if the demand for new cars falls rates may also fall irrespective of what the Fed does.

By all accounts, the Fed is poised to raise its benchmark rate at least several times this year. Will that tame inflation? We will have to wait and see. The one thing we do know is that lenders and other creditors will respond one way or another.

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