Grow Your Money

Why You Should Care About Rising Interest Rates

January 28, 2016
by Nate Matherson
Contributor
federal funds rate

It finally happened.

For the first time since June 2006, the Federal Reserve raised interest rates.

In December, the Federal Open Market Committee (FOMC) approved a 0.25% interest rate hike, which would increase the federal funds to 0.25%-0.50%.

Set by the Federal Reserve, the federal funds rate is the interest rate large banks use to lend each other money overnight. Most FOMC members expect current federal funds rates to settle around 0.375% before the next rate hike.

So what does the federal funds rate increase mean for you? In short, a lot.

Interest rates are everywhere.

Do you have a credit card? Student loan? Mortgage? Savings account?

If so, think about how rising interest rates will influence your personal finances over the next few years.

Low interest rates have been a luxury for millions of indebted American consumers — and they seem to have become the new norm. While you may not care about the interest rates banks use to lend each other money, you should know how the hike will impact your finances in the coming year.

Your Credit Card Debt Will Cost You More

American consumers currently hold a whopping $714 billion in credit card debt, according to the Federal Reserve’s Quarterly Report on Household Debt and Credit.

Credit cards almost always carry variable interest rates, which change with market interest rates. Nearly all credit card interest rates are calculated based off a widely accepted floating interest rate, which is tied to the the federal funds rate.

So, all credit card borrowers should keep their eyes on the federal funds rate. A rising interest rate means higher interest expenses for credit card borrowers.

For individuals with large amounts of credit card debt, even small interest rate changes can add up to hundreds or even thousands of dollars in additional interest expenses.

So Will Your Student Loans

If you have or are planning to get student loans, you should also take notice.

Each July, Congress sets federal student loan interest rates as a derivative of the 10-year Treasury note rate. Rising market interest rates will lead to increasing interest rates for new student loan borrowers.

That means if you’re planning to get a student loan next year, your interest rate will likely be higher than this year’s.

Any current federal student loans should be unaffected, since they’re issued with fixed interest rates.

However, if you have private student loans, you might not be as lucky. Many private student loan borrowers have variable rate loans.

The average college graduate will leave campus with about $29,000 in student loan debt this year, which means rising interest rates on new and current private loans could have a significant impact.

Virtually all types of consumer debt will be impacted by higher interest rates.

Mortgages, auto loans, credit cards, student loans and personal loans all will get a little more expensive this year.

But Rising Interest Rates Can Be Good, Too

On the flip side of the equation, rising interest rates may also benefit your personal finances.

If you’re a Penny Hoarder, rising interest rates might actually be a good thing.

Have you checked your savings account recently?

Over the last few years, savers have been put in a tough spot. The national average savings account interest rate is only 0.06%, according to the Federal Deposit Insurance Corporation (FDIC).

For the average consumer, rising interest rates will offer greater savings earnings. The same can be said for consumers with interest-bearing checking accounts and money market accounts.

So how should you prepare for rising interest rates?

You have time to create a personal finance plan — interest rates aren’t going to increase that quickly. The economy is still in recovery mode.

The Federal Reserve is going to be extremely careful not to raise interest rates too often or quickly. Analysts are expecting a slow and steady pace for the next few years. But it’s never too early to create a plan.

Plan to Take Advantage of Higher Interest Rates

Start by paying off variable interest debts.

Additionally, consider refinancing variable rate mortgages, auto loans and student loans to fixed rates.

Fixed rates are at historic lows. If you lock yourself into a fixed rate, you won’t need to worry about your total loan cost or monthly payment increasing.

This won’t be a great year for savings accounts, but it should be better than 2015.

While interest rates might seem like a dry topic, they can have a huge effect on your finances, so make sure to take the time to consider how you can minimize any problems they’ll cause you, and take advantage of the chance to help your money grow.  

Your Turn: How will rising rates affect your personal finances?

Nate Matherson is the Co-Founder and CEO of LendEDU, a marketplace for student loans and student loan refinancing. You can email Nate directly at nate@lendedu.com.

by Nate Matherson
Contributor for The Penny Hoarder

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