A higher federal funds rate can have both positive and negative effects, depending on whether you’re trying to borrow or save money. Changes in interest rates might even dictate whether you can afford bigger life purchases, such as a home, a car, or even college tuition.
When the Fed raises the federal funds target rate, the intention is to increase the cost of credit throughout the economy. Higher interest rates make loans more expensive for both businesses and consumers, resulting in everyone spending more on interest payments. People who can’t or don’t want to deal with higher payments may put a hold on projects that involve financing during this time.
This entire process reduces the supply of money in circulation, which works to lower inflation and stabilize economic activity. In the past the money supply has gone down when the Federal Reserve raises banks’ reserve requirements, which resulted in them lending out less money. Rising interest rates inevitably impact mortgages, stocks, bonds, credit cards, personal loans, student loans, auto loans, and business loans.
You Might Pay More for Debt
Borrowing can become more expensive when the federal funds rate is raised, so if you’ve been thinking about refinancing a debt, the best time to do it is when the rate is still low. The amount you pay toward credit cards and loans with a variable rate will most likely increase as the federal funds rate increases, costing you more money. And, it could even become more expensive to take out new loans with fixed interest rates. So if you’re considering taking out a new loan or mortgage, consider trying to lock that in now, too.
Still, with more rate hikes planned for later this year, it’s probably not a bad idea to try to put your extra funds toward your debt now, if you can. You can work to pay off high-interest credit cards if you’re carrying balances, since it will cost you more when interest rates go up. A good method for paying down credit card debt is to target the balance with the highest interest rate first, which is known as the debt avalanche method.
You Might Earn More on Savings
On the other hand, rising interest rates are ideal for your savings account because higher rates may earn you more money. Since many savings accounts’ interest rates are closely tied to the target federal funds rate, you may see a little more in your account(s). It may even be more encouraging to save money during this time to potentially earn more with these higher rates through compound interest. Local banks and credit unions can offer some of the most competitive rates when it comes to savings accounts, along with online financial institutions.
What to Know About Federal Interest Rate Increases is written by Rachel Velez for www.chime.com