What happens when the Fed raises its interest rates? | Investment
Let’s take a look at how this applies to a 1% increase in the federal funds rate and how this could impact the lifetime cost of a home mortgage loan.
Take a family out for a 30-year, $ 300,000 fixed rate mortgage. If the banks offered them an interest rate of 3.5%, the total lifetime cost of the mortgage would be about $ 485,000, of which nearly $ 185,000 was interest charges. Monthly payments would be approximately $ 1,340.
Suppose the Fed raised interest rates by 1% before the family got a loan, and the interest rate offered by banks on a $ 300,000 mortgage went up to 4.5%. Over the 30-year life of the loan, the family would pay a total of over $ 547,000, with interest charges amounting to $ 247,000 of that amount. Their monthly mortgage payment would be around $ 1,520.
In response to this increase, the family in this example might delay buying a home, or move to a home that requires a smaller mortgage, to minimize their monthly payment amount.
This (very) simplified example shows how the Fed reduces the amount of money in the economy when it raises its rates. In addition to mortgages, rising interest rates impact stock and bond markets, credit cards, personal loans, student loans, auto loans, and business loans.