Fed up? Or Fed down?
In recent months, you’ve likely heard the phrase “interest rates” more often than usual, as the Federal Reserve raised the federal funds rate for the first time since 2006. This is a national policy that may impact your wallet, depending on where you are in your financial life.
The basics of interest rates
The Federal Reserve changed the federal funds rate, which dictates how much banks and credit unions pay to borrow money. “Overall, the fed sets short-term rates that banks borrow at,” explains Lindsey Myhre, Vice President of Finance at STCU, “and the market determines long-term rates like the 10 year treasury rate, which typically sets mortgage rates.”
The prime rate – typically considered the lowest rate given to commercial borrowers – and often a benchmark in setting home equity lines of credit, is set by financial institutions and tends to be about 3 percentage points above the federal funds rate. When the prime rate changes, it eventually is passed on as a change to consumer loan and savings rate.
How rising rates impact credit cards
Variable-rate credit cards tend to change quickly when interest rates go up. Check your credit card terms and conditions to see if it’s fixed or variable rate.
If your variable interest rate is based on the prime rate, it may be going up soon with little to no warning. If your card has a fixed interest rate, and you’re current on your monthly payments, then you will receive notice from the card issuer if your rate changes.
Either way, this is an excellent time to start paying down your credit card balance if you can. Or do some research to see if you could transfer your card balance to another card at a lower interest rate. That would help you to pay down the principle of your credit card debt, rather than just making payments on the interest.
How rising rates impact loans
Like credit cards, rising rates will impact loans if the interest rate is variable. Fixed-rate loans should not be affected to rising rates, but if your loan is variable, such as an adjustable rate mortgage or revolving line of credit, then you should determine how the interest rate changes are calculated on your loan and plan accordingly. If there is a long life left to the loan, it may make sense to refinance the loan to a fixed rate.
If you don’t currently have loans but are thinking about making a big purchase soon, then you should carefully research what that loan will cost. Small changes in interest can affect the payment and your ability to repay a loan. For example, a 4 percent APR home loan for $300,000 over 30 years would require a monthly payment of $1,400, while a 6 percent APR loan on that same home would cost $1,800 each month.
How rising rates impact savings
Savings accounts rates at most financial institutions tend to respond to rising rates, but slower than credit cards and loans. That’s because banks and credit unions will cautiously wait to ensure they have an adequate net interest margin between what they can charge for a loan (interest earned) and what they must pay depositors on their savings (dividends paid).
For short-term savers, this means interest rates are not likely to rise significantly in the near future. But if you’re saving for the long term, then rising interest rates could begin to boost your savings dividends in the next few years.
The bottom line
Living in an economy with rising interest rates means that borrowing money is probably going to get more expensive, but saving money is likely to pay you back even more.
No matter what the rates, the basics of good financial health — budgeting carefully, paying off or reducing the cost of your debt, tucking a few extra dollars into savings, and planning ahead – all remain the same.