In December, while you were most likely preparing for the holidays, the United States Federal Reserve raised interest rates one quarter of a percent. That small amount may not seem like much, but it signaled a big change in the minds of many economists. The US Federal Reserve hadn’t raised rates since June of 2006, and generally when they notch rates up, it means a series of interest rate increases are on the way.
So, what does this mean? Let’s dive a little deeper.
The Federal Funds rate, the interest rate that the Federal Reserve actually controls, is the amount of interest charged when banks borrow or lend for ultra short periods of time. This interest rate is then passed on to customers of those banks in their loans; so while you don’t have the Federal Reserve as your bank, any moves by the Fed will show up a few ways:
- Lines of Credit: Any money you borrow from a bank that isn’t a mortgage will be affected by Fed movement. If your loan is at a fixed rate, you have nothing to worry about. The bank is obliged to maintain that rate. However, if you have a variable rate loan, you could see your interest rate go up soon.
- Auto loans: These types of loans are closely affected by the Federal Funds rate. If you’re going to buy a car soon and not use cash, the rate will be higher than that they’d have charged you just a few months ago.
- Savings: Banks need people to save money with them so it’s available to loan to others. They offer higher rates on savings products like CDs to lure more money into their coffers. When the Fed raises interest rates, and they earn more on their outstanding variable rate and new fixed rate loans, there’s more money to give to savers.
Many people think mortgage rates are tied to the Federal Reserve (you may have even seen radio and television commercials from some lenders propagating this idea). That’s not true. Mortgage rates are tied to long-term US Treasury bonds. When the Federal Reserve moves their interest rate, however, often US Treasury bond prices move also, so there is some correlation…but it isn’t immediate.
Okay….so what should I do?
If you’re worried about what a rising interest rate environment will do to your financial situation, here are two tips:
- Check to see if you’re in fixed rate or variable rate loans. If variable, you’re potentially at risk. Either work faster to pay off variable debt or see if you can transfer it to fixed rate loans without paying through the nose to make the switch. This is especially important with mortgages, where a one or two percent change can be hundreds or even thousands of dollars of new interest charges. Once again…mortgages aren’t directly tied to Fed moves, but over time when all interest rates begin to rise, mortgage rates will also fluctuate.
- Check your savings account interest rate. If you’re at a brick and mortar bank and don’t use your bank branch often, maybe think about moving to an online bank. Sure, you won’t have local ATM access, but many banks offer ATM reimbursement, checks, and deposits via your smartphone. The difference can be amazing. Sites like MagnifyMoney.com and nerdwallet.com show the average brick and mortar bank paying savings account interest rates of .1 or .2 percent, while online banks, which are also insured by FDIC, are paying in some cases a
The best idea? If you keep your debt to a minimum and use fixed rate loans, you won’t have to worry about the Fed from a debtor perspective. Without debt, you can transfer your energy to one of my favorite questions: how do I find solid returns on my savings? THAT is a fun question to answer (and one we’ll tackle soon in another article!).