Q&A; : Consumers Will Feel a Bump

The decision Friday by the Federal Reserve Board to raise the federal funds rate to 3.25% from 3% is expected to have a small but broad impact on consumers and investors in the near future. While this rate increase is small, further hikes may be on the way.

Here are answers to some commonly asked questions about what is going on.

Q: What is the federal funds rate?

A: The federal funds rate is the rate that banks charge each other for overnight loans. Banks regularly borrow from each other to make sure they have the cash needed to meet federal regulatory standards. When their borrowing costs go up, banks usually pass those costs on to consumers by charging higher interest on everything from credit cards to mortgages.

Q: How does raising the federal funds rate fight inflation? Doesn’t it simply make borrowing money more expensive for banks and consumers alike?

A: Initially, yes. But when the government raises interest rates, borrowing becomes more expensive and less attractive. As a result, companies borrow less and consumers usually spend less--which eventually slows down the economy and eases long-term inflationary pressures.

Q: Then how will Friday’s increase affect my investments in the stock market?

A: The rate hike triggered a broad selloff in stocks and bonds Friday, and the Dow Jones industrial average dropped nearly 100 points. But some Wall Street analysts said many of those sellers were simply nervous about the Dow being at record levels and essentially used the Fed’s action as an excuse to take some of their profits. The market could recover much of those gains next week after the dust settles.

Still, if you’ve made some hefty profits from the market’s long bull run, financial planners say, you might want to sell at least some of your stocks now and put the proceeds into a money market fund until the direction of interest rates comes into sharper focus. Long-term, the Fed’s action could actually prolong the rally in the stock market if it keeps rates from soaring later.

Q: What about bonds?

A: Bonds have been some of the market’s best performers as interest rates have steadily dropped since 1989, but they generally don’t do well when rates are rising. However, if the Fed is successful in keeping inflation in check, the bond rally could eventually resume as long-term interest rates fall, even if short-term rates rise.

Q: Is the Fed expected to implement more rate hikes?

A: Most analysts expect regulators to raise the fed funds rate at least one or two more times over the next several months. With further rate increases apparently on the way, it’s probably wise to lock in a fixed rate if you’re planning additional borrowing.

Q: Since interest rates are going up, can I expect to earn more on my certificate of deposit?

A: Experts are divided on an answer. Some said Friday that rates on CDs, savings accounts and interest-bearing checking accounts will probably move up a bit because lenders will want to continue attracting deposits.

But others said CD rates will remain unchanged because most financial institutions are already awash with cash and don’t need to raise their rates to lure additional deposits. Even if rates rise a little, it should not add much to your interest earnings.

Q: What does the Fed’s move mean for borrowers?

A: People with variable-rate credit cards will probably feel the pinch first, because their cards are tied to short-term rates and their payments can rise quickly. Auto loan rates could also jump soon.

Q: What has the Fed’s rate hike done to mortgages?

A: Most lenders started to raise their rates on 30-year mortgages about a week ago, as fears spread that the Fed would act soon. Calabasas-based ARCS Mortgage, one of Southern California’s biggest lenders, is representative of many financial institutions: It was charging 7.25% and one upfront point on its 30-year, fixed loans Friday, up a quarter of a point from a week earlier. The increase would add $25 to the monthly cost of a $150,000 mortgage.

People who have adjustable-rate mortgages tied to short-term indexes, such as the one-year Treasury bill, could see their payments rise soon. Some lenders also raised their prime rate Friday, and borrowers with mortgages and home equity credit lines linked to the prime will also suffer if more lenders follow suit.

However, most California ARM borrowers have their loans tied to the 11th District cost of funds index, a composite index that reacts to interest rate swings very slowly.