Consumers Squirm as Fed Hikes Interest Rate

Key interest rates are marching in the same direction, up, and the Federal Reserve Board did nothing to stop the trend yesterday by raising the federal funds rate. What's that got to do with the price of eggs? From a consumer's standpoint, the federal funds rate, which Fed Chairman Alan Greenspan and company tweaked up by a quarter-point on August 24, means higher borrowing costs for home-equity loans, credit cards and some personal loans. Combined with mortgage interest rates recently topping 8 percent, that's bad news for homebuyers and other consumers, although rates have been even higher in years past.

The only encouraging words out of the Fed were, in effect, "that's all folks..." no further increases are expected this year. But together with the last quarter-percent increase last June, the rate now stands at 5.25 percent. The Fed's short-term rate does not directly affect mortgage rates--mortgages are more closely tied to U.S. Treasury notes. But higher Fed interest rates mean U.S. banks will charge higher prime interest rates, raising the costs of money in the financial system. Interest charges on home-equity lines of credit, credit cards, and some personal loans will go up. The only possible bright side for consumers would be slightly higher returns for certificates of deposit, money market accounts and interest-bearing checking accounts.

Some analysts say that things aren't all that bad. The Fed actually cut rates last fall by three-quarter percent when world financial markets were in danger of collapse. Thus, rates are still lower today.

On the mortgage front, Freddie Mac reported that the average interest rate for a 30-year fixed-rate mortgage edged down to 7.93 percent for the week ending August 20, 1999. That's down from last week's average of 8.15 percent; a year ago, the 30-year rate averaged only 6.92 percent. Homebuyers can counteract higher rates by taking out an Adjustable Rate Mortgage (ARM). Why is the interest rate so important to the first-time homebuyer? Because generally speaking, you'll be paying more interest than principal during the early years of owning your home.

Your monthly ARM payments will be lower to start off with because these loans generally begin with an interest rate that is 2-3 percent below a comparable fixed rate mortgage. You could use the lower rate to buy a more expensive home, or use the savings for other needs. What's the catch? The interest rate changes at specified intervals (for example, every year) depending on changing market conditions and the particular "index" your rate is tied to. If interest rates go up so does your monthly mortgage payment. However, if rates go down, your mortgage payment will go down, too.