Fed Announces Rate Hike for First Time in a Year: 5 Things You Should Know

For the first time in a year and only the second time in the past decade, the Federal Reserve announced plans Wednesday to raise interest rates.

The move is not a surprise from the country's central bank, whose chairwoman, Janet Yellen, signaled repeatedly in recent months that a rate hike would happen this December. Now, as expected, the central bank will raise the federal funds rate a quarter of a percent. While the rate is currently hovering between 0.25 percent and 0.5 percent, the Fed will push it up to between 0.5 percent and 0.75 percent.

What the Fed affects directly is the federal funds rate, which is the rate banks pay to lend to each other overnight. But this isn't the same as the interest rates average people can expect to pay. Mortgage rates nationwide, for instance, average close to 4 percent.

So what does today's announcement mean? Here are five takeaways for the average American:

1. Overall, a single rate hike won't change all that much.

Greg McBride, chief financial analyst at Bankrate.com, points out that though the single quarter-point hike is virtually negligible for the average American, the cumulative effect of several rate increases could make an impact on a family's budget.

2. However, the Fed's actions indicate it is serious about tighter monetary policy, and that could impact your pocketbook down the line.

If the Fed raises rates a few more times over the next year, that could push mortgage rates up as well. A family considering a $400,000 mortgage could end up paying more than $170 more a month if their interest rate climbs from 4 percent to 4.75 percent.

McBride suggests homeowners lock in a fixed-rate mortgage as soon as possible so that they can get lower prices. Many financial advisers are skeptical of adjusted-rate mortgages because your payments may spike when rates rise. Since the Fed may well continue to raise rates into the future, you can't be confident in what your payments will be down the line.

3. Consider paying down your debts.

People with other forms of debt like credit card payments or auto loans would also do well to pay these down while rates are relatively low. If you let your debt build up and your interest rate rises, you'll end up paying a lot more in the long run.

4. Savers benefit from higher rates.

If you're someone who has a large nest egg, an upward trend in rates is all upside. High interest rates eventually translates into larger payments on vehicles such as savings accounts.

As Chief Economist Curt Long for the National Association of Credit Unions put it, "For typical Main Street Americans, the move serves as a reminder to review the rates on their savings and borrowings and to shop around. They may find that even in a low-rate environment there are institutions willing to provide superior rates and higher-quality service than the big Wall Street banks."

5. Climbing rates might spell doom for President-elect Donald Trump's plans to stimulate the economy.

His plan to provide $1 trillion over 10 years, mostly in tax breaks to incentivize infrastructure development, could run into trouble if the Fed decides to continue raising rates.

The essential problem is that with the unemployment rate low — it dropped to 4.6 percent last month — the Fed sees little reason to keep rates low to stimulate the economy.

Some argue that the unemployment rate doesn't tell the whole story because it only counts people who are looking for work, not those who have dropped out of the workforce entirely. It's possible a booming economy could draw some of these discouraged people back to the employment search.

In the event of a large government investment program such as Trump's, businesses might raise wages to attract people back into the workforce.

But this would likely lead to inflation, which has consistently fallen below the Fed's target of 2 percent. If inflation rises, the Fed will be even more likely to hike interest rates to compensate, and this would reduce any impact of the government's spending program.

"The Fed will not make any assumptions about President-elect Trump’s economic agenda," said Long. "A large spending bill accompanied by tax cuts certainly has the potential to increase growth and inflation, paving the way for faster rate normalization in the coming years. But the Fed will stick to its wait-and-see approach.”

McBride noted that unlike recent votes Federal Open Market Committee, Wednesday's showed the board in complete agreement.

"The dissent from the Fed is gone, at least this time around," he said. "The vote was unanimous, and considering the recent tone of economic data, that is no surprise."

Photo credit: Kurtis Garbutt via Flickr