Q & A : How the Fed’s Latest Action Will Tighten Purse Strings

The Federal Reserve Board’s decision Wednesday to raise short-term interest rates by half a percentage point will directly affect mortgage and other loan rates, as well as what is paid on investments ranging from bank deposits to Treasury bills and money market mutual funds.

Nonetheless, the impact of the move will not be as drastic as those of previous Fed rate hikes, experts noted, because it was so widely anticipated. For example, mortgage rates, which had been creeping up during the last several days, actually fell slightly once the decision was announced.

Here are some answers to questions about how the higher rates may affect you:

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Q: Are my credit card payments going to rise?

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A: If you have an adjustable-rate credit card, yes.

Expect notice of a rate change--probably up 0.5 percentage points--within 60 days. Most adjustable-rate credit cards tie their rates directly to the prime rate, which rose to 9% from 8.5% on Wednesday.

Rates on fixed-rate credit card debt may also rise, but more slowly. And hikes are more likely on low-rate cards than on higher-rate cards, where the profit margins are healthy.

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Q: What about my mortgage? I have an adjustable-rate mortgage that’s tied to the Treasury bill index. Am I about to get creamed?

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A: Not from what happened today. Short-term Treasuries moved fairly modestly--between one-tenth and one-quarter of a percentage point--on Wednesday. But these rates have been climbing for several weeks in anticipation of another Fed increase. But if you’re about to face a rate adjustment for the first time in a year--many of these loans reprice just once annually--get ready for a shocker. Short-term Treasury rates have popped up by about 3 percentage points during the last year.

If you have an annual interest rate cap, your interest rate can only jump between 1 and 2 percentage points per adjustment. If you don’t, your payments are likely to soar. Other adjustable-rate guides are also likely to inch upward.

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Q: Will the Fed’s action push up rates on fixed-rate mortgages?

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A: Oddly enough, no. While the move boosted certain short-term rates, the long end of the market took it as an encouraging sign that the Federal Reserve was serious about fighting inflation--and likely to be successful--says Gary Schlossberg, senior economist at Wells Fargo Bank in San Francisco. As a result, the rate for 30-year fixed-rate mortgages dropped slightly, says Earl Peattie Jr., president of Mortgage News Co. in Santa Ana. Last week, the average rate charged on 30-year “fixed” notes in California was 9.103%, he says. Today it was 8.927%.

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Q: Will I earn more on my savings and investments?

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A: Probably. Banks are slowly raising the rates they pay on deposits, but these increases have been smaller than the rise in prime. That’s simply because deposit rates are based both on market rates and on each bank’s need for funds. Banks are still not desperate for cash to provide for new loans. Until they are, interest rate hikes will be modest.

Indeed, the deposit market took the news with something of a yawn, says Martin Bradshaw, president of Bradshaw Financial Network, a Seattle-based company that tracks deposit rates. While deposit rates have been rising steadily for the last several weeks, many deposit categories didn’t budge on Wednesday and others moved by just a hair, he says.

If you invest in money market mutual funds, however, you are likely to see rising returns as the funds buy higher-yielding short-term Treasuries.

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Q: How will the rate hike affect the economy?

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A: It is designed to slow things down. When interest rates rise, the cost of borrowing to buy things rises too. That means both businesses and individuals can afford to buy less. Consumer spending is the main force driving economic expansion, so when consumers pull back so does the economy. The point of all these Fed moves is to prevent a return to the days of high inflation without pushing the economy into recession.

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Q: This is the seventh rate hike since last February. Is this it, or are there more on the horizon?

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A: It is possible that the financial markets and bond holders may become convinced that inflation is under control for the long haul. If so, long-term rates--such as those of “fixed” mortgage loans and 30-year bonds--will begin to fall again, and so will short-term rates. The answer will become clearer over the next several months as the markets--and the Fed--begin to see economic indicators.

* HIKE NO. 7

Federal Reserve raises short-term rates by half a percentage point. A1