Don’t panic about rising interest rates
If you’re still worried about the ways the Fed interest rate could impact your finances, there are a few additional points to consider:
- Again, rising interest rates won’t impact fixed-rate loans that you already have. Your monthly payments on fixed-rate mortgages, car loans, and student loans will remain the same.
- You may want to think about consolidating or refinancing from variable-rate loans to a fixed-rate loan if you’ve already noticed your payment go up.
- APRs on credit cards may go up, but the specific interest rate you receive if you apply for a new card also depends on your own credit score.
How a low interest rate environment makes borrowing more attractive
The answer to, “How does the Federal Reserve interest rate affect me?” can be a positive one in a low-rate environment if you have debt or are looking for new borrowing opportunities. When the Fed cuts rates, borrowing money tends to become less expensive since banks and lenders also typically lower rates on their credit products.
In a low-rate environment, for example, you could see lower rates on:
- Credit cards
- Auto loans
- Personal loans
- Private student loans
- Home equity lines of credit
- Adjustable-rate mortgages
- Business loans
Why the federal interest rate matters for consumers and the credit cards in your wallet has to do with minimum payments and interest charges. A Federal Reserve rate cut could translate to a lower minimum payment on credit cards and a lower cost to carry a balance from one month to the next. When it comes to the relationship between a Fed rate cut and a savings account, interest rates will often fall for those accounts, too. For loans, a Fed rate cut could mean lower monthly payments and less interest paid out over the life of the loan. Lower borrowing costs can add money back to your budget that you could use to spend, save, or apply to your financial goal of choice.
If you’re wondering how the Federal Reserve affects mortgage rates, there’s good news there, too. When the Fed lowers rates, homeowners with an adjustable-rate mortgage and homebuyers shopping for one may experience a rate reduction, since the rates for this type of mortgage typically track with the prime rate, which is in turn influenced by the federal interest rate. The lower your mortgage rate, the lower your monthly payment and the more home you might be able to afford. Keep in mind that fixed-rate mortgages are less directly impacted by a Fed rate cut.
Chad Rixse, director of financial planning at a wealth planning firm, says that when rates are falling, it may be a good time to consider refinancing or consolidating existing debt, such as private student loans, home loans, and car loans. (Refinancing means replacing your existing loan with a new one at a lower rate. Consolidating means paying off multiple loans with a single new loan.)
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When answering, “How does the Federal Reserve interest rate affect me?” for yourself, Adams adds that consumers should be mindful of how much rates have dropped to determine the value of refinancing or consolidating. Using mortgages as an example: “They should not consider refinancing a mortgage after a 25-basis point (0.25%) cut in the rates because the associated costs and fees will outweigh any interest savings,” Adams says. “If rates move meaningfully lower (1.00%+), they should be on the lookout for refinancing offers, assuming they have significant time remaining on their mortgage and can benefit from lower interest costs.”
How changing interest rates can affect spending habits
The ripple effects of the federal interest rate even extend to your purchasing power and everyday spending.
“By raising the federal interest rate, the Fed makes it more attractive for banks to hold extra capital,” says James McGrath, a housing market expert and licensed real estate broker at a New York-based real estate firm. “When more money is locked away in vaults, there is less available to make loans and buy things, which slows growth and inflation.”
If inflation is kept to a minimum by the Fed’s benchmark interest rate, prices for things you buy every day—think groceries or personal care items—have less room to increase. If a Fed rate change keeps those everyday prices low, you can put more of your money toward savings or paying off high-interest debt.
On the flip side, McGrath says the Fed can lower rates to spur spending. That puts more money into the economy, but it does open up the potential for prices to rise, he says. Higher prices could mean that your money has to stretch further to buy the same things, especially on big-ticket items like a college education or a mortgage.
How the Fed can influence federal mortgage interest rates
It can be tricky to figure out what assets do well with rising interest rates and what assets do better with falling rates. When it comes to understanding how interest rates affect mortgage rates, you might experience even more confusion. The Federal Reserve doesn’t set mortgage rates, but it does indirectly influence them. When the federal interest rate is rising, you’ll often see mortgage interest rates rising, too. In 2022, the federal mortgage interest rates are higher than they were in 2020, because the Fed raised rates and federal mortgage rates reflect that trend.
Keep in mind that the fluctuations in interest rates only affect those with adjustable-rate mortgages and those who are currently shopping around for a mortgage. If you already own your home and entered into a fixed-rate mortgage, your interest rate is locked in.
Stay informed and stay the course amid falling or rising interest rates
Look at your overall financial situation against the backdrop of what’s happening with rates. Your list of ways the Fed interest rate affects you might be different than someone else’s. Ask yourself how you can take advantage of rising or falling rates for maximum financial benefit when it comes to your borrowing, saving, and spending priorities. For example, if the Fed hikes rates and you’ve been building up a college savings fund for your children, you may be motivated to put more into savings to take advantage of higher returns. If rates are cut and you’ve been in the market for a loan for some time, now could be the time to jump on it.
Note that the ways the Fed interest rate affects you may also depend on more than just one Fed rate change. “Small changes don’t amount to significant differences over time,” Adams says. “It’s when a long-term rate increase or decrease path becomes the norm that consumers should pay more attention,” he adds.
Above all, remember that rate increases and decreases are a normal part of what the Fed does. “Remain calm and carry on,” Rixse suggests. “Don’t let panic or negative emotions guide your decision-making.”
In 2022, the Fed began aggressively raising rates to combat inflation. Learn more about inflation and its effects on your savings, plus how to protect your savings when prices rise.
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Source: discover.com