Worried about all the ways the Fed interest rate could impact your finances? That’s totally natural, considering the Fed and its interest rate hikes have dominated headlines for months. Many people get spooked when interest rates come up. Rising rates can raise a lot of questions: Will rising interest rates impact your finances by making mortgages too expensive? Could you miss out on your chance to borrow while it’s still cheap to do so? These questions are valid when talking about rate hikes, but making decisions based on news headlines alone can be problematic.
What are interest rates?
Understanding what interest rates are, why they’re rising, and what that means for your finances can go a long way in helping you understand your financial future. Let’s say you’re shopping for a car. You probably know that interest rates can affect your monthly payments. One car loan’s interest rate might go up, while a different loan might offer lower rates than you’re used to. This is because each loan has different interest rates. This is called an interest rate “spread” — it’s the difference in the average interest rates for different loans. The higher the rate, the less you pay on your loan. After calculating the difference in your car loan interest rates, you’ll find out that you can expect a lower monthly payment if you take out a different loan.
Benefits of interest rates
Any time your investments or money grows, it’s generally a good thing. It just means the underlying investments, like your money in a 401(k), aren’t getting weaker. Similarly, the Fed rate hike will help keep the economy from getting too strong. Inflation will also be lower with a higher rate, meaning people can spend more money on the items they want without having their money go too fast. The point is that higher interest rates are, for the most part, good. Higher interest rates are good. On the other hand, interest rates are not always good. High rates can be bad for investors because of their potential effect on a retirement account. If you’re trying to put money away for the future, you want to make sure it stays as safe as possible.
How would interest rates increase
Rate hikes come in stages. Interest rates increase from 1% to 2% each year, but sometimes there are one-time increases. To illustrate how increases in rates work, let’s look at a real-life example. A 2% federal income tax rate — higher than the current top rate of 37% — is the rate most commonly used when discussing rising interest rates. If the top tax rate increases to 35%, your savings will effectively increase from 2% to 3%. This example isn’t meant to paint a rosy picture. There are several ways the federal government could increase tax rates (you can read more about this here) and the potential consequences could be disastrous for some people. Still, it provides a quick way to illustrate the basic concepts involved in increasing interest rates.
Effects of rising interest rates on finances
In many ways, it’s best to avoid making hasty financial decisions solely on the basis of the Fed interest rate hikes. Consider these key pieces of the puzzle: The Fed’s intent when raising interest rates is to slow down growth in the economy and bring interest rates up to more normal levels. The Fed believes that slowing down growth and slowing down interest rates are positive outcomes. When they’re behind the scenes planning interest rate hikes, they’re thinking of how rising rates will impact the economy in general. After all, rising rates only affect things that are tied to the economy, such as mortgages.
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Impact on mortgage payments
First, when it comes to purchasing a home, your mortgage interest rate affects the size of your monthly payment and how long you’ll need to pay it off. You may assume that it’s not high enough to change your monthly payment, but that’s incorrect, as shown in the analysis from Bankrate.com. According to that report, an owner of a $200,000 home pays on average $844 per month in mortgage interest. The percentage change in that mortgage rate over 12 months, would lower your monthly payment by $23 per month. That could be enough for you to pay off your mortgage earlier, although there’s no one-size-fits-all rule for the size of your monthly mortgage payment. Interest rate changes may make it more expensive to make a mortgage payment for the rest of your life.
Impact on Car loans
When interest rates rise, the average car loan rate in the United States tends to rise with it. But there are a few different ways rising interest rates could impact you if you’re buying a new car. First, let’s look at the latest Federal Reserve interest rate hike. In December, the Federal Reserve raised the Fed Funds rate from a range of 1.25% to 1.5% to a range of 1.75% to 2% after keeping rates at 1.5% for over seven years. This was the third interest rate hike in 2018, and the second of the year. Under this rate hike, some borrowers, such as people who currently have loans at 2.5%, will likely see their rate increase.
Impact on credit card rate
Credit card interest rates move in tandem with interest rates. When interest rates rise, the credit card interest rate (and associated fees and interest) also rise. Unlike mortgages and other loans, interest rates on credit cards typically are not fixed, so even a single percentage point change in interest rates will have a noticeable impact on the balance you owe. Changes in credit card interest rates depend largely on two factors: the Federal Reserve’s moves and the credit card issuer’s strategy. In general, issuers are more likely to increase rates when the Fed is raising rates and lower rates when the Fed is lowering rates. When interest rates are rising, issuers are most likely to lower rates on credit card balances.
Impact on Private student loans
If you borrowed money to go to school, you may have private student loans. Private student loans aren’t backed by the Federal Government, but instead by the investor. To gauge if your private student loan is affected by rising interest rates, ask: Are your payments going up? Will I get a new student loan, or another loan, with more favorable terms? If you have outstanding federal student loans, you may be looking forward to an exciting new federal student loan program. According to the Department of Education, there will be a new federal student loan for students that will allow them to borrow money to pay for their education without making payments for a set period of time.
Impact on Returns on savings
Not all people pay close attention to the Fed, but those who do have reason to be concerned. Here are the reasons why: While rising interest rates could theoretically be good for investors, it is still negative for savers. The chart below illustrates how fixed-income investors stand to lose money on fixed-income investments that are already priced relatively low by the market. Because the market rate is already higher than the interest rate on a savings account, a 1% higher market rate will make all savers poorer. On the other hand, many investors are at risk of losing their money in the stock market when rates rise, since the stock market is priced higher than it has been in a long time.
It’s a lot to think about when you look at all the variables at play. However, it’s critical to know how rising rates impact you. It’s often best to sit down and think about your needs, finances, and financial goals before diving into any decision. The more prepared you are, the more confidence you’ll have when making the best choice for you.
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