You’ve probably seen the headlines: the Federal Reserve hiked interest rates to historic levels.
The Federal Reserve lifted its benchmark rate by 0.75%, marking the largest single increase in 28 years. In doing so, the Fed is signaling its determination to bring inflation, which has been running at 8.6% over the past twelve months, under control.
While this news might sound bad – and financial media will certainly do its best to make it sound that way – it’s important not to overreact or panic. Here’s what this interest rate raising means for you, your wallet, and the economy going forward.
Why Did the Fed Raise Interest Rates?
The federal funds rate is the interest rate at which banks borrow and lend to one another. While consumers won’t be paying this rate, it still makes borrowing money more expensive.
So, why does the Fed raise interest rates anyway? They hope to “cool off” our economic climate – essentially, trying to tame out-of-control inflation rates (currently at 8.6% as of May 2022).
How does that work? When prices get higher, people tend to spend less money. This, in turn, slows down the economy and — gradually — brings inflation down to more moderate levels.
This balancing act is tricky because while the goal is to slow inflation, everyone wants to avoid triggering a recession.
While things might get more expensive in the near future, the long-term future looks bright if everything goes according to plan. The overall target? To bring inflation down to 2% while keeping unemployment at 4%.
Want smart updates on the world of money?
Will You Be Paying an Extra 0.75% Across the Board?
The short answer is no. It’s not time to hide your money under your mattress. This rate isn’t what consumers like you pay; rather, it’s what banks have to pay to borrow and lend to one another.
Of course, this means there is a trickle-down effect. Think about everything you need a bank for: mortgage, car loan, personal loans, etc. Even though you won’t feel that 0.75% right now, you should be prepared to see a difference in borrowing and savings rates.
What Should You Do to Prepare?
Higher interest rates mean consumers may want to think differently and strategically about debt and savings.
Since banks have a larger bill for doing business, they’ll likely pass some of those expenses to borrowers. This means if you’re looking for a bank loan, expect higher interest rates. Here are some interest rates to be mindful of:
- Credit cards:
- Most credit cards charge variable interest rates based on the “prime rate” that the Fed influences. So if you carry a balance, prioritize paying it off. The average interest rate for new credit card offers is a whopping 18.68%! You certainly don’t want that rate compounding every month you don’t pay off your balance.
- Debt with variable interest rates:
- Not all debt has fixed interest rates; some are variable, like adjustable mortgage rates or home equity lines of credit (HELOC). With rising interest rates, it might make sense to shop around for a fixed policy — though those are also higher than average. If you’re close to paying off your home remodel, it might make sense to redirect more money to that loan.
- Fixed interest rates are also getting more costly:
- If you’re wanting to buy a home today, your interest rate picture will look much different than a year ago. Today, the national average for a 30-year fixed mortgage is 5.94%; in June of 2021, it was 2.98%.
- Even though the Fed doesn’t control auto loans, expect your new car to be more costly. Since the price of purchasing and maintaining a car is getting more expensive (i.e. low supply, expensive gas, etc.), you’ll feel that at the dealership.
The Good News? Your Savings May Earn More
But higher interest rates aren’t all bad, at least from where your high-yield savings accounts are sitting.
That’s right; savers can finally expect to see some higher interest rates in their savings accounts and certificates of deposit (CDs).
Rates have been historically low, which has raised concerns that savings won’t be able to keep up with inflation. Now, you might see those earnings get a bit higher.
The bottom line? It will likely cost more to borrow, but you’ll likely earn more in savings. That’s the double-edged sword of higher interest rates.
The Long-Term Plan
Remember, the Fed isn’t hiking interest rates “just because.” This is a long-term plan to curb inflation and slow the economy so it returns to a more balanced and manageable place.
But don’t expect inflation to stabilize overnight. It will likely take some time until more familiar inflation levels return.
What can you do in the meantime?
- Double down on your debt repayment plan
- When possible, pay your debt balances in full each month; as a bonus, try allocate more towards the principal
- Refinance your loans to lower rates
- Keep saving
Reach Out to an Abacus Advisor
It can be challenging to navigate the tough times of high inflation, rising interest rates, and a wobbly stock market. But if history is any guide, these times won’t last forever.
As we often like to remind our clients, this is the routine cycle of business. Temporary volatility and market corrections are the price we pay for enjoying higher returns on our investments. Without this volatility, those higher returns wouldn’t be available to us.
That doesn’t always make it pleasant. But know that you don’t have to go through this alone. Reach out to an Abacus advisor today and see how we can help you build a comprehensive, robust financial plan to weather market storms.