And it all starts with an increase in what's called the banks' prime lending rate.

How Fed hikes work their way to your wallet

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The prime rate is reserved for bank customers with the best credit.

The prime rate is the interest rate that major banks extend to their borrowers with tiptop credit. Think of it as the banks' "best rate."

Despite a common misunderstanding, the prime is not set by the Federal Reserve, though it is closely tied to the federal funds rate. That's the benchmark interest rate that the Fed controls.

Each time the central bank makes a change in the federal funds rate, the big banks almost immediately make a similar move with the prime.

Federal Reserve policymakers just hiked their rate by another one-quarter of one percentage point. Banks will respond by pushing up the prime from 5.25% to 5.5%.

Why does the Fed keep raising rates?

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The Fed has been moving rates higher and higher.

Federal Reserve officials set their target for the federal funds rate based on how well the economy is growing and the outlook for inflation.

The Fed tends to lower its interest rate in times of high unemployment, a sluggish economy or weak inflation. And that pushes down the prime.

But whenever the economy is booming in a way that could heat up inflation, the central bankers raise the federal funds rate to keep spending and prices under control. And the prime rate goes up, too.

If you're unhappy about rising interest rates, look at it this way: They're going up because good economic growth is expected for 2018 and 2019. And that's a positive thing!

Credit card, HELOC rates will go up quickly

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The prime has a direct impact on credit card rates.

If you've got credit cards (and who doesn't?) or a home equity line of credit, better known as a HELOC, you feel the movements in the Fed's rate and the prime rate most directly.

Interest rates on those products change in lockstep with the prime. In fact, the adjustable rate on a HELOC might be advertised as "prime plus 1%" or "prime plus one," for example.

That means the rate on a hypothetical home equity line would go from 6.25% to 6.5% as the prime rises from 5.25% to 5.5%.

You can expect to pay higher interest on your plastic or your HELOC soon after any rate hike from the Federal Reserve.

Other borrowing costs will rise, too

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Rates on auto loans and mortgages are expected to rise also.

Rates on auto loans, personal loans and some adjustable-rate mortgages also piggyback off the prime.

And while fixed mortgage rates don't necessarily follow the lead of the federal funds rate and the prime, they can be influenced by those benchmarks indirectly.

The Fed is expected to keep raising rates in 2019, and mortgage giant Freddie Mac expects 30-year fixed mortgage rates to climb, too.

Timing is crucial when you’re deciding to borrow money. If you’re in the market for a mortgage, an auto loan or a personal loan, you may want to latch onto a lower rate while you can.

About the Author

Doug Whiteman

Doug Whiteman


Doug Whiteman is the editor-in-chief of MoneyWise. He has been quoted by The Wall Street Journal, USA Today and and has been interviewed on Fox Business, CBS Radio and the syndicated TV show "First Business."

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