You may see news about the Fed raising rates and wonder, “How does this affect ME?” Before we share the top five ways the fed rate affects you, here’s a quick overview.
What is the federal funds rate?
The Federal Reserve requires banks to keep money on reserve to remain ready to meet their obligations. Sometimes, banks have to borrow from each other to reach the minimum reserve required, and the federal funds rate is the interest rate that a bank pays on such a loan.
Why does the Fed adjust the rate?
When the federal rate is low, prices tend to rise, causing the dollar to lose value — which is called inflation. The Fed tries to fight inflation by raising the rate. The rate has been near zero for years, so increases now are more about getting the rate back to neutral (3 to 3.5 percent).
Five ways a federal rate hike affects you ?
1. Higher rates on savings and CDs?
Following a rate hike, savers may see a slight increase in savings account interest rates. This is especially helpful to retired people on fixed incomes who rely on interest rate income. Rate hikes more readily lead to higher yields on certificates of deposit (CDs), which typically require you to lock in an investment for one to ten years.
TIP: Look for higher interest rates offered by banks and credit unions following a rate hike and consider moving to a bank product that offers the highest interest return!
2. Higher loan rates, increased lending, economic growth ?
When interest rates are higher, banks have more incentive to loan out money — which is typically beneficial to customers and economic growth.
Nearly all lenders price their fixed rates relative to the prime rate, which is about 3 percentage points higher than the federal funds rate and moves up and down along with it. So an increase in the federal rate will likely increase the rates available to borrowers. It won’t affect the rate on any loans already underway.
TIP: If you’re considering a new loan, it could be advantageous to lock in a lower fixed rate now, as rates are expected to rise in 2018.
3. Higher credit card interest rates, fewer low-interest offers ?
Most credit cards charge variable interest rates tied to the prime rate, so when the federal funds rate drives up the prime rate, credit card rates follow suit. If you’re carrying a credit card balance, you will likely feel the effects of a rate hike and pay more interest on your debt.
This is another way that a rate hike fights inflation, because when the Fed sends credit card rates higher, people tend to buy less on credit. That slows the economy and curbs inflation.
TIP: Try to reduce your credit card debt and take advantage of low-interest card offers while you can.
4. Stronger U.S. dollar, benefitting U.S. travelers ?
As we said above, a higher fed rate helps fight inflation. Therefore, when the rate is higher, the U.S. dollar is typically stronger. And typically a strong U.S. dollar gives U.S. travelers more buying power in other countries.
TIP: Watch exchange rates and consider planning a trip as the U.S. dollar becomes stronger and has more buying power
5. Increased home values, higher mortgage rates ?
As the Fed raises rates, higher mortgage rates will follow. Most home buyers choose a 30-year, fixed-rate mortgage. Adjustable-rate mortgages (ARMs) may be inched higher, and any homeowners who have ARMs today may want to consider refinancing at a low fixed rate. If you’re planning to buy or refinance a home soon, you may want to secure your rates now.
The fact that potential home buyers may be compelled to buy now, rather than later, is good for home values. If more people rush to buy before rates get higher, it will increase demand, raise prices, and boost home equity.
TIP: Refinance or purchase a home before rates climb, or sit back and watch your home value increase as buyers rush to get into new homes before rates rise.
The new normal
Many investors and economists expect the Fed to keep gradually increasing the federal funds rate in the foreseeable future, so keep the tips above in mind as 2018 unfolds!