January 10, 2024 By bmapk

What Happens to Your Finances When Interest Rates Go Up

• • The federal government recently announced a 0.50% increase in interest rates, following a long period of record lows.
  • Inflation has reached historic highs, and the new rate is an attempt to slow it down.
    There are a few ways in which your personal finances could be affected by a rise in interest rates. Getting a loan of any kind now generally costs more.
  • Perhaps you’ve read about it in the news recently. In early May 2022, the Federal Reserve raised interest rates by another half a percentage point.

Although 0.5 percentage points may not seem like much, it represents the highest increase since the year 2000. Fed Chair Jerome Powell has stated publicly, “We’re strongly committed to restoring price stability.” In 2023 and 2024, experts predict, prices may increase again.

But what does that mean for the average American who is working hard to make ends meet and put away a nest egg for later? What effect, if any, do high interest rates have on the economy as a whole? Is there going to be an increase in prices?

Let’s take a step back and examine the impact that higher interest rates will have on your family’s finances.

U.S. Government Interest Rates
Okay, let’s rewind for a second. Can you please define the Federal Funds Rate? And what’s the big deal anyway?

This rate is used as a benchmark to establish the cost of interbank loans with varying terms. It is also linked to numerous consumer debt products with variable interest rates. It had previously been set at an exceptionally low 0.00% to 0.25%. Due to the recent increase, it is now between 0.75 and 1.00 percent.

Many facets of the American economy are affected by the Federal Interest Rate. When borrowing money becomes more expensive, companies (and customers) tend to spend less as a result. It may also reduce the return on your money. There are others in the financial industry who believe the Fed should keep raising rates until they reach 3%. It last reached that level in February 2008, when the housing crisis first began and the Fed lowered rates as a response.

Rates of Interest and Price Growth
Now that we’ve established what the Federal Interest Rate is, we can move on to the more pressing issue at hand: why is it increasing? To put it briefly, “to fight inflation.” Exactly how does that function, though?

Inflation refers to the general trend of rising prices over time. It averages between 1.5% and 2% each year under standard conditions. However, enormous inflation rates are expected in 2022 for a number of reasons. We are witnessing inflation between 7% and 12%, depending on the source (and the month) you select for your computations.

To at least somewhat control inflation, the Federal Reserve adjusts interest rates. When the price of borrowing money rises, businesses and individuals alike tend to reduce their discretionary spending. The dollar appreciates when lending slows and spending slows. The effects of inflation can be mitigated when the value of the dollar rises since more dollars can be bought with each one. However, the adjustments that interest rate shifts impose are rarely visible for about a year.

Paying the Mortgage
Those with adjustable-rate mortgages are among the hardest hit by a rise in interest rates. When referring to interest rates, the phrase “variable rate” is synonymous with the benchmark federal funds rate. That means some people’s mortgage payments will go up when the Federal Reserve raises rates. A “fixed mortgage” is a loan in which the interest rate remains constant for a set period of time. Your payments, thankfully, will remain the same. The bad news is that by the time your mortgage is up for renewal, interest rates may have increased significantly.

The payments on a mortgage with a variable interest rate will increase substantially faster. It’s a risk you take when you choose a mortgage with such features. When the federal government lowers the interest rate, you benefit, but when they raise it, you have to pay more. Call your mortgage company and check if you can lock in a rate before it rises, if you have the option to do so.

Rent
Perhaps you are currently renting instead of purchasing a home and therefore do not need a mortgage. That’s understandable given how challenging it is to save enough money to buy a house these days. What will happen to your rent payments if interest rates continue to rise? The terse response to this question is “It depends.”

In areas where rent is regulated, increases to tenants’ monthly payments cannot exceed a maximum authorised by law. A significant rent increase may result from failure to do so. After all, you can bet that your landlord has a mortgage on the property. And it’s possible that their mortgage payment simply went up.

Learn about the local and state regulations that affect landlords and tenants. Before agreeing to any rent increases, you should familiarise yourself with your rights as a renter.

Funding for Automobiles
Car loans, like mortgages, come in a wide range of forms. Car loans with adjustable interest rates are not frequent, but they do exist. There is no difference between getting a loan to buy a car, truck, motorcycle, boat, RV, or even just some high-priced furniture or equipment. If you financed the purchase of such items using a loan with an adjustable interest rate, the payments may soon be more than expected.

In a similar vein, the cost of new fixed-rate loans will increase. In order to keep pace with the federal rate, interest rates for dealer and third-party financing transactions will also rise slightly. You should probably hurry up and get that new car (or boat, or whatever) before interest rates go up even more.

Rates for Credit Cards
Credit card interest rates are typically significantly higher than the prime rate. However, the Annual Percentage Rate (APR) on some credit cards is subject to change. That means if the federal rate goes up, your credit card interest will go up as well. It can increase your minimum payments each month (but you should really pay more than that).

First-time credit card applicants, especially those with less-than-ideal credit, will feel the pinch of a rate increase. Because of the new, higher interest rate, businesses will be more selective in who they extend loans to. Credit cards with reduced interest rates could be accessible to those with less than stellar credit histories.

Personal Loans for College
The interest rate on federal student loans will never fluctuate, which is good news. Your payments will remain the same regardless of what the federal government does. (Unless debt relief for students is actually passed, which is another story.) Variable interest rates may apply if you take out private student loans or refinance your federal loans through a private lender.

You may have to pay more each month for your student loans if interest rates rise. You should go to your lender right away if you have an existing variable-rate loan and want to see if you can lock in a rate. After all, the federal funds rate is probably going to go up again in the near future.

Your Savings’ Rate of Return
At last, some encouraging information When the rate of interest offered by the federal government rises, your savings will grow at a quicker rate. A half percent might not seem like much, and you’d be right. But whether your savings account has two hundred dollars or one hundred thousand dollars, it’s still extra money.

Higher returns can also be found in other forms of savings, such as Certificates of Deposit (CDs) and Money Market Accounts. However, this is a slow and steady progression. There is, however, a drawback to this. Savings account earnings won’t be able to keep up with inflation as the federal government raises the interest rate to do so. Although the total value of your money is increasing, your real savings are falling. The reason for this is that the purchasing power of that money has decreased due to inflation.

Entrepreneurship
Increasing borrowing rates has knock-on effects, one of which is a reduction in the number of new small businesses being founded. Rising interest rates discourage would-be business owners from taking out loans to cover initial expenses. It’s a calamitous result of inflation. Those local establishments have the potential to bolster the economy by hiring thousands, if not millions, of Americans.

There is some good news, too. Low unemployment is a side effect of high inflation and interest rates. Since the prices of goods and services have gone up, it has become more difficult for businesses to attract and keep qualified employees without increasing pay. That’s great news for the workforce, which is still in high demand despite the improved conditions.

What to Do When Interest Rates Rise
Interest rates are out of your control. The federal government will choose a setting based on their best judgement, and you’ll just have to live with it. Though it may put a strain on your finances, there are certain measures you can take to alleviate the situation.

Identify any loans or debts with variable interest rates as a starting point. Home loans, auto loans, credit cards, and home equity lines of credit all count. If they are, contact your lender to enquire about refinancing to a fixed rate. You should do the math to figure out which choice is best for you financially, in case there are any penalties involved.

Score of Creditworthiness
Keeping or raising your credit score is another strategy for dealing with high interest rates. Any time you need to borrow money, your credit score will be taken into account. Your interest rate may be based on the federal rate, but if your credit is poor, you won’t be offered anything but extremely high-interest loans or credit cards. That’ll cost you a little bit more cash.

No matter what happens to federal interest rates, monitoring your credit score is essential. Paying your bills on time, cutting your debt, keeping an eye out for errors on your credit report, and maintaining financial stability are always vital, but they take on added significance when interest rates are on the rise, as they are today. If you need to borrow money in the near future, a solid credit score will help counteract rising interest rates.

Investment in the Stock Market
Investing is a great defence mechanism against the twin threats of rising interest rates and inflation. The stock market typically yields a yearly return of 6–10% if invested for a sufficiently extended period of time. If you find that your money isn’t going as far as it once did, investing in things like mutual funds or stock indexes can help you build up some emergency savings.

If you’re already stretching to pay the rent or buy groceries, the idea that you should set aside a portion of your income each month to invest in the stock market may seem counterintuitive. However, the cost of living isn’t going down anytime soon. If you can commit to regular investment today, you’ll set yourself up for a far better future.

In Conclusiveness
In the face of soaring inflation, the Federal Reserve has no alternative but to increase interest rates. In the long run, this action ought to help bring inflation under control. The cost of borrowing money will rise for everyone as a result. That can include money you borrowed in the past and are currently repaying.

Find out if your debts have variable or fixed interest rates. You should look at switching to a fixed rate if you can. Think things over thoroughly if you anticipate needing a loan in the near future, whether it’s for a home, car, or business. With the recent increase in interest rates, your previous spending plan may no longer be viable. You may need to make more modifications to your borrowing strategies if the rate continues to rise.