How Fed rate hikes will raise borrowing costs for young workers

The Fed raised its benchmark interest rate at the end of its September meeting, signaling further rate hikes could be considered later this year.

For consumers, this move could have a significant impact on borrowing costs and savings yields. Short-term consumer borrowing rates generally track roughly the Fed’s benchmark, but long-term loans are tied to the yield on 10-year Treasury bills, which recently hit a 19-year high.

Experts say U.S. Treasury yields have soared on expectations that inflation will remain high, raising the possibility of further rate hikes.

Additionally, because inflation is outpacing wage growth, workers lose purchasing power and have less financial cushion. With affordability already a major concern, a prolonged tightening could put additional strain on many households, but not all households will be affected equally.

“Rising interest rates naturally hurt younger borrowers with lower incomes and help older savers with higher incomes,” said Thomas Phillipson, former chairman of the White House Council of Economic Advisers.

“Raising rates is a blunt instrument. Raising rates will make it harder for families to borrow and will increase the cost of auto loans, credit cards, mortgages, and more,” Heather Boushey, a professor of practice at the Kleinman Center for Energy Policy at the University of Pennsylvania and a former member of the Council of Economic Advisers, also said in an email.

“The first people to feel the pain are going to be individuals with variable-rate debt,” said Colin Slavack, a clinical assistant professor at New York University’s School of Professional Studies.

“Credit card APRs, home equity lines of credit, adjustable rate mortgages, and some private student loans can become expensive relatively quickly,” Slabach said. “While a quarter-point increase may seem small, the effect is cumulative for households with large balances or those already struggling to make monthly payments.”

For example, Americans have a total of about $1.26 trillion in credit card debt, according to the latest report from the Federal Reserve Bank of New York. Approximately 60% of credit card users carry revolving debt, which means they are currently paying an average of more than 23% annually on their monthly balances.

The 25 basis point increase will cost credit card borrowers an additional $2 billion in interest over the next 12 months, according to a separate analysis by personal finance site WalletHub.

Credit cards are often a consumer’s first line of defense in an emergency, but the financial burden rarely ends there. Research shows that people who owe a lot of money on plastic are more likely to have other unsecured debts, such as personal loans or buy now, pay later.

Alternatively, Moody’s chief economist Mark Zandi said wealthier households are generally in a better position to absorb higher interest rates: “They’re less likely to need to borrow, and if they do have debt, it’s because of the low-interest mortgages they locked up during the pandemic.”

In fact, according to Realtor.com’s latest quarterly report, about 19.5% of mortgages currently have pandemic-era interest rates of 3% or less, little changed from last year. Additionally, 15-year and 30-year mortgage rates are fixed, giving homeowners some protection from interest rate increases.

However, tightening monetary policy could also help curb spending and borrowing, effectively cooling the economy and easing inflationary pressures.

“History strongly supports the idea that in the long run, restoring price stability is more important than providing immediate but lasting relief,” said Mark Higgins, senior vice president at Index Fund Advisors and author of “Investing in U.S. Financial History: The Past to Predict the Future.”

“It’s especially valuable for low-income Americans because persistent inflation erodes their purchasing power, requiring them to make more painful sacrifices,” Higgins said.

Inflation has been “too high for too long,” Chairman Kevin Warsh said at a press conference after the Fed raised its benchmark interest rate and then signaled the possibility of more rate hikes.

“Assuming Mr. Warsh follows through, I believe his approach will be in the long-term benefit of all Americans,” Higgins said.

But, he added, “that doesn’t mean there won’t be painful short-term costs from higher borrowing rates and increased labor market pressures in different demographic groups.”

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