When the Fed Hikes Interest Rates, Who Gets Hurt?

• Updated March 22, 2023, to reflect the latest Fed rate increase.

The Federal Reserve hiked interest rates by 25 basis points on Wednesday, the ninth increase since March 2022 in its efforts to cool a hot economy. The Fed rate is currently 4.75% to 5%.

Federal Reserve Chairman Jerome Powell said in September that he wishes “there were a painless way” to lower inflation. “There isn't,” he said.

So who is going to feel the pain?

Borrowers

To lower overall prices, the Federal Reserve is raising interest rates. The intended effect is to make borrowing more expensive. That might seem counterintuitive: What’s the point of fighting inflation if not to reduce consumers’ costs? But when the price of credit goes up, consumers become less likely to borrow, and thus, to spend. And when consumer spending declines, that puts downward pressure on prices throughout the economy.

The Fed’s approach “has the delicacy of a blunt ax,” says Kathryn Edwards, economist and professor at the Pardee RAND Graduate School. But increasing the price of credit is one of the only tools the Fed has for combating inflation.

Home loans are expected to get more expensive (more on that below), but borrowers can also expect higher rates on personal loans and auto loans. It might be more difficult for small-business owners to secure affordable loans, and that could dampen new businesses, says Brad Hershbein, senior economist and deputy director of research at W.E. UpJohn Institute for Employment Research. And the most vulnerable borrowers could also face even higher payday loan costs than usual.

There are signs borrowers are taking on more debt than usual. The average personal loan debt held is $10,344, as of the second quarter of 2022, credit bureau TransUnion found — that’s a 20% increase in average debt since the same time in 2019. Climbing interest rates coupled with a vehicle shortage has pushed the average auto loan balance to more than $20,000, according to July 2022 data from credit bureau Experian.

The combination of higher balances and higher rates makes it more difficult for borrowers to repay: Delinquency rates for personal loans hit 3.37% during the second quarter of 2022, TransUnion data show. It’s the highest delinquency rate since the start of the pandemic.

High delinquency rates will likely lead to more borrowers defaulting on their debts, resulting in a bevy of negative consequences such as collections costs, credit damage, property seizure and wage garnishment.

Home buyers and renters

Mortgage rates on a 30-year loan rose past 7% in November, the highest in 20 years, according to Freddie Mac, a government-sponsored enterprise that provides capital to the mortgage market.

Another worrying sign: Despite their contribution to the 2008 housing market crash, adjustable-rate mortgages have once again become popular with home buyers trying to avoid locking in high fixed rates. Borrowers who do take on these types of loans risk unaffordable payments if rates continue to rise.

The cost of mortgages will reduce prospective borrowers’ ability to buy homes, one of the central ways people build wealth, says Edwards. And the fallout will hit prospective first-time home buyers the hardest. First-time home buyers are disproportionately young people and Black people of all ages.

Data analyzed by the National Association of Realtors finds Black people have the lowest homeownership rates among racial/ethnic groups. Its analysis found Black applicants are twice as likely to be denied a mortgage as white applicants.

Meanwhile, rents are showing signs of falling since hitting highs earlier this year, according to data from real estate company Redfin. But experts say that the downward course could reverse as would-be first-time home buyers stay in the rental market.

Landlords with adjustable-rate mortgages could also raise rents to compensate for their increased borrowing costs, says Hershbein.

“That could affect more economically vulnerable people,” he says.

Retirees and near-retirees

As of 2019, the majority of baby boomers were still working. Then the pandemic hit, forcing many boomers into early retirement.

Those who did retire, especially lower-income retirees, have some protection from rising prices: The latest 8.7% cost-of-living adjustment for Social Security beneficiaries was the largest increase in 40 years.

But it might not be enough to combat the aftereffects of interest rate hikes.

“A lot of low-income older workers, because of the Social Security bump, have a great incentive to stop working at age 62, whereas higher-income workers will probably end up working a lot longer,” says Hershbein. In this way, the cost-of-living adjustment might ultimately reduce low-income workers’ retirement income in the long term.

Rate hikes could make it more difficult for older Americans to retire and for current retirees to stay retired. Here’s why:

• Dips in 401(k)s and IRAs. Interest rate hikes usually result in tumbling stocks (the S&P 500 is down about 20% from its 2022 peak), which can play havoc with retirement accounts.

• Increased home costs. Homeowning retirees with adjustable-rate mortgages will have higher costs to meet.

• Downsizing difficulties. Retirees who want to sell their homes may have a more difficult time doing so due to higher rates for new mortgages. Likewise, it could be more expensive to try to purchase a smaller home or enter a costly rental market.

Most retirees are on a fixed income, which means higher costs of goods and services are making it more difficult for them to keep up. That alone could force retirees back into the workforce, but if unemployment increases, reentering the labor force could be difficult.

Low-wage workers and unemployed workers

So far, interest rate hikes haven’t caused a recession. And the U.S. continues to boast some of the lowest unemployment numbers in history. But all that could change if the Fed keeps raising rates.

"For working Americans who already feel the crush of inflation, job losses will make it much worse," wrote U.S. Sen. Sherrod Brown, D-Ohio, chair of the committee on banking, housing and urban affairs, in a letter to Powell. "We can’t risk the livelihoods of millions of Americans who can’t afford it."

Unemployment insurance claims are not the best barometer of an impending recession, both Edwards and Hershbein agree. Hershbein says to keep an eye on the speed and downward trajectory of quit rates and job openings.

Higher quit rates signal the ability of workers to move from job to job, one sign of a healthy job market. A sudden drop in quit rates can be a bad sign, but if they come down gradually, the Fed might just be able to get inflation under control without triggering a recession.

“Despite the Fed moving as aggressively as it has, it hasn’t caused a crash yet, but what if they get that calibration wrong?” says Hershbein. “It’s like a pot of boiling water: It looks like it’s simmering just fine, then you turn away and the whole thing boils over. It can happen that quickly."

Unemployment during a recession tends to exacerbate perpetual problems in the labor market. Namely, the highest rates of unemployment fall on low-wage and part-time workers, as well as Black workers at all wage levels.

But Edwards says it’s possible that employers will be less inclined to shed staff in the event of a recession than they had been during the COVID crash when 22 million Americans lost their jobs.

“After having a hard time hiring those 22 million back, they feel like their workforce is less expendable,” says Edwards. “They might prefer not to fire people if they don’t have to.”