How Rising Fed Interest Rates Affect You
Federal interest rates are now at their highest levels since 2008.
The Federal Reserve approved a .25% hike in interest rates at its March 2023 meeting — the third time rates have gone up since November 2022 — in an attempt to curb runaway inflation.
In December, the Fed upped interest rates by half a percentage point, then hiked them again by .25% in both February and March.
The latest Fed increases brings the main policy rate to a range of 4.75%-5%, the highest it’s been since January 2008 amid the Great Recession.
In general, a rate increase is good for savers, and we may see some drops in prices of consumer goods.
But the hike is bad news for borrowers who will see mortgage, consumer loans and credit card rates jump even higher this year.
At the March 2023 meeting, Fed Chairman Jerome Powell indicated that they’ll monitor the situation as to whether more interest rate increases are to come.
What Rising Interest Rates Mean to You
Just to be clear, the federal interest rate is the rate at which banks borrow money from each other. But the rise and fall of that interest rate affects consumer interest rates on savings accounts, credit cards, mortgages and other personal loans.
Simply put, your credit is going to become more expensive. Most credit card companies provide variable rate interest, which means they can (and will) change interest rates on the balances you carry from month to month when the Fed raises interest rates overall.
The current average variable rate for credit cards that charge interest is now about 19.07%, according to Federal Reserve, up from about 14.56 % at the beginning of 2022. That rate is only expected to inch higher.
Take home message: Do what you can to pay down credit cards now. It’s a good time to have money saved, and a bad time to have accrued debt.
If the Fed continues to raise the benchmark rate, this might be a time to consolidate your debt to a credit card with the lowest interest rate, or find a zero interest balance transfer offer that, for a limited time, would allow you to pay toward reducing the balance and not increase interest payments.
If you currently have a fixed-rate mortgage, the interest hike will not impact your monthly payments.
If your rate is variable, it’s about to go up, and your monthly mortgage payment will rise.
The current average fixed mortgage rate on a 30-year loan is 6.32% in March 2023, down from the previous record of 7.08% in October 2022, according to Freddie Mac. The average fixed morgtage rate on a 15-year loan is currently at at 5.56%.
Should you want to refinance in response to the change in rates, the available bank rates are also going to rise in response to the Fed’s actions. The prime rate also impacts home equity lines of credit, so you should consider looking to reduce that debt amount as well.
Millennials and Generation Z have enjoyed historically low mortgage rates much of their adult lives. First-time home buyers might be shocked, especially as rising interest rates collide with escalating home prices.
Now, consumers looking to buy a home can expect to pay more interest, which had been close to zero. First-time home buyers might be the most affected because they will see increased interest rates with fast-rising home prices in many markets.
It’s going to cost more to buy a car on a payment plan — but interest rates aren’t the only factor driving up car prices.
Your overall interest costs will depend on the interest rate you qualify for. In general, the higher your credit score, the better your rate will be.
New car prices have remained stubbornly high since the pandemic. At first, supply chain issues and chip shortages were to blame. While some of these issues have been resolved, inventory remains low compared to pre-pandemic levels, which means car prices aren’t likely to come down anytime soon.
Interest rates on car loans for buyers with lower credit ratings are most likely to increase as a result of the Fed Reserve’s hikes.
As of March, the average interest rate on a 60-month (or five-year) auto loan is about 6.55%, according to the Federal Reserve’s latest data. Expect that number to climb.
Find out if your loan is a fixed rate loan (most federal loans are) or a variable rate loan.
The federal student loan forgiveness program announced under the Biden-Harris Administration is currently being challenged in the Supreme Court. Whether or not you submitted an application, the program’s fate remains uncertain for now. It’s important to start preparing your finances should student loans not be wiped out. A final decision is expected to be made by the Supreme Court this summer.
Private loans can be refinanced the same way a mortgage is, and there will be competition among lenders for new business as a result of the new Fed prime rate.
Interest on Savings Will Increase
It may be difficult for consumers to find good news related to a rise in the federal prime interest rate but there is one tidbit: earning more interest on savings.
If you have a savings account, you’ve likely seen your interest rate grow to more than 3% recently. That’s a big change from the paltry .5% or less that savings accounts were offering as early as a year ago.
When the Fed raises prime rates for borrowing money though, the rate offered by federally insured banks for saving money rises too. It’s a great time to be saving money versus holding debts or borrowing money.
Why the Fed Raises Interest Rates
The Federal Reserve uses the benchmark interest rate to regulate the economy.
The higher the interest rate, the more expensive it is to borrow money for major purchases such as homes and cars, thus slowing commerce and battling inflation. The lower the interest rate, the less expensive it is to borrow money, thereby invigorating a sluggish economy.
Since December 2008, in response to the Great Recession, the benchmark rate has been unusually low, starting at near 0% and rising to 2.25% in December 2018, about a year before the pandemic struck.
In response to the economic calamity caused by the pandemic, the interest rate dropped again to near zero in March 2020 and didn’t change until two years later in March 2022. Since then, it’s been going up from there.
Several issues have contributed to inflation — including supply chain issues, the Russian-Ukrainian conflict, pent up consumer demand and three pandemic relief payments.
How to Prepare Your Finances Now Ahead of More Federal Rate Hikes
- Pay off high-interest debts ASAP: As mentioned, as the Fed raises interest rates, interest rates on your credit card debt will rise, too. APYs will climb, only further compounding your debts. It’s best to pay down credit card debts as quickly as you can to eliminate financial burdens — and to boost your credit score!
- Add money to a high-yield savings account: While interest rates on debt rise and borrowing money becomes more expensive, those of you who do have cash saved will see higher interest payments. Add as much extra money to your savings as you can, and you’ll see more earned interest every month.
- Start a side hustle: Side hustles have become the lifeblood of millions of Americans, especially after the initial onset of the pandemic. Side hustles like driving for Uber or Lyft or delivering groceries with Instacart or Shipt are smart ways to earn extra cash on your own time, and pad your earnings in case of higher debt payments.
- Use cashback apps to get paid from your purchases: Cashback apps like Rakuten and Fetch can put some coins back in your wallet for all of the everyday purchases you already make, like on Amazon or at your favorite local restaurant. Signing up for apps like these is an easy way to take money back that you’d otherwise be leaving on the table.
- Cut back on unnecessary purchases: We all love to grab dinner with friends, catch a movie or plan a trip. But if you’re feeling that you’re debt-saddled in 2023, it’s wise to spend less on what’s frivolous. Also, it’s a good idea to focus that extra money on debt reduction and building an emergency fund.
Frequently Asked Questions (FAQ)
We’ve rounded up the answers to some of the mostly commonly asked questions about rising interest rates.
The Federal Reserve uses the prime interest rate to stimulate or slow the economy, based on current economic patterns. With inflation topping an astonishing 9% and the cost of everyday goods rising, the Fed decided to bump the rate to slow borrowing and purchases on big ticket items like homes and automobiles.
Such action is aimed at slowing inflation, although the Federal Open Market Committee has raised rates it to about 4.75-5% as of March 2023. This suggests that several more rate hikes are still on the horizon for 2023.
Increases in interest rates impact both inflation (positively) and employment (negatively).
When the Federal Reserve increases the benchmark interest rate for borrowing, both public and private lenders follow suit. As a result, any interest cost included in a purchase is going to go up.
Mortgage rates and all loans will see increased interest rates for borrowing, and the interest rate on your credit card balances is likely to increase as well.
Generally, it means the economy is booming, and doing so too fast for the good of the country’s consumers, whose income cannot keep up. When the Fed increases the prime interest rate, it is usually aimed at reducing the annual inflation rate, which indicates how much the cost of consumer items change from one year to the next.
The interest rate hike won’t affect your mortgage if you have a fixed-rate mortgage. If you have a variable rate mortgage, that rate is likely to increase slightly, and will change again as the Fed makes more benchmark rate increases throughout 2023 and beyond.
This might be a good time to consider a refinance to a fixed-rate mortgage to avoid surprises down the line.
When it comes to spending or borrowing money, there are no disadvantages other than overextending yourself by acquiring too many loans or credit cards.
When it comes to savings, low interest rates make it unappealing.
Kent McDill is a veteran journalist who has specialized in personal finance topics since 2013. He is a contributor to The Penny Hoarder.
Adam Palasciano is a personal finance-obsessed and money-savvy individual who loves to create content on all things saving and making money. His work also appears on The Smart Wallet, FinanceBuzz, Yahoo! Finance and JoyWallet.
Rachel Christian, a senior writer for The Penny Hoarder, also contributed to this story.