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WASHINGTON -- Rumors are flying about a possible increase in the Federal Funds Rate at the next Open Market Committee meeting of the Federal Reserve on May 19, and the bond market already is becoming jittery.
But just what does that mean to the consumer who holds a variable rate credit card, an adjustable-rate mortgage or a home equity loan? The Fed fund rate impacts the prime rate and many consumer products are tied to prime.
A rate hike could mean higher interest rates and higher monthly payments, for one thing. And although most market observers agree a 0.25 percent increase in the Fed rate would have minimal impact, it could prevent some people from refinancing their home loans. Some consumers who have been on the fence about trying to refinance may want to try now, and still others who are teetering on the edge between qualifying for a loan and not qualifying could be pushed into that pile of "unacceptable" applications.
"In terms of qualifying for loans, there are a few people at the borderline who might lose out with an interest rate increase," said Fritz Elmendorf, vice president of communications for the Consumer Bankers Association in Arlington, Va. "Indexes will change. Increasingly, there are more credit cards and home equity loans based on the Fed rate plus 1 percent or so, and these rates would increase."
Consumers don't balk at small increases
For the most part, Elmendorf said, consumers don't fight a slight interest rate increase. That's because the impact on their payments usually is so small; a 0.50 percent increase would mean only $5 a year on a $1,000 credit card balance, or roughly 40 cents per month more in interest.
If mortgage rates increased only 0.25 percent, the payment on a $100,000, 30-year fixed-rate loan previously priced at 7 percent and now priced at 7.25 percent would increase $17 per month from $665 to $682.
Adjustable rate mortgages tied to Fed rate would also bump up, and monthly payments would be refigured.
"The margins on these loans are clearly stated in the consumer's contracts," Elmendorf added. "It's not flexible and if a change occurs, the rates will go up. People usually don't argue about such slight increases."
Borrowers may shop around
However, at National City Bank in Zionsville, Ind., branch service representative Ann Belcher said when the Fed rate moves, people start shopping around for lower rates.
"They'll come in to us with a certain figure they want to get on a loan or a credit card, and if we can't do it, they go somewhere else," Belcher said. "If their rates rise on adjustable loans, they try to refinance them. Sometimes we can help, sometimes we can't."
A one-time increase in the Fed rate may not make a significant difference to the consumer, said Dan Hanson, senior vice president and division manager for Norwest Mortgage, Riverside, Calif.
"It would have to be a sustained series of increases in the rate before it would really have an impact," he said. "Interest rates went up six times in 1994 and that really affected the outlook. I actually think rates between 7 percent and 8 percent are very attractive to the consumer. It may slow the (refinance) market a bit, but it's not enough of a projected increase to make a difference."
What happens to confidence?
The other intangible impact of a Fed rate hike is the effect on consumer confidence, said Ken McEldowney, executive director of the nonprofit consumer advocacy group, Consumer Action, San Francisco.
"People might be wondering if this is the first shoe, in terms of rate increases, because it's been such a long time," McEldowney said. "Rates have been frozen for more than a year, and an increase could have more of a psychological effect on consumers."
A rate increase would affect credit card rates for the first time in more than a year, and there may be more balance transfer activity, he noted.
In the home loan arena, a higher Fed rate could accelerate the trend toward fixed-rate mortgages and away from adjustable-rate loans.
"And those consumers who have been on the fence about refinancing their home loans may want to do it now, because they may think rates will keep going up," McEldowney added. "The impact probably will be minimal, but much of it depends on consumer confidence."
Calm should prevail
Other observers believe that confidence is high, and don't think a rate increase would have any serious impact on the economy.
"The Fed has been very cautious, and any move on their part would reflect their view that continued caution is needed," said Doug Duncan, senior economist for the Mortgage Bankers Association, Washington.
Long-term mortgage rates are already rising, Duncan noted, and the movement is not surprising.
"An increase in rates would definitely reduce the refinance activity and any people on the margin, probably lost out on the near term," Duncan said. "But we think the magnitude of the change will be moderate for borrowers."
Consumers could begin to worry about inflation
Others think the impact of a Fed rate hike on the consumer remains up for debate. Shirley Rooker, president of the consumer group Call For Action in Bethesda, Md., said she believes if consumers think this is a sign of inflation worries for the national economy, it could have a negative impact.
"Just talking about an increase has impacted the stock market, and that directly affects the consumer," Rooker said. "Not to mention those with variable-rate credit cards and adjustable mortgage and home equity loans tied to prime ... they're all looking at higher rates if the Fed moves."
In her market near Washington, for example, home sales are booming for the first time in years.
"Home sales activity here has been astonishing, and it's a direct result of lower interest rates," Rooker said. "If rates rise, who knows what could happen? People thinking of moving up into a bigger home may not want to now. People who carry revolving charges will have higher rates on the principal owed. It depends on individual consumer circumstances. We've been enjoying an unprecedented boom, though, and I feel optimistic about it."
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