Perhaps you’ve seen the news that the Federal Reserve has been raising interest rates steadily throughout 2022. The Federal Funds Rate, is the rate at which banks borrow and lend money to each other overnight. It also affects the overall economy, including interest rates on consumer loans. So how might rising interest rates affect your finances? Let’s look at a few ways you might be impacted.
Rising interest rates can affect your investments in various ways, and bonds are the most straightforward example of this. Typically, as interest rates rise, bond prices fall, and vice versa. Why does this happen? Bonds are essentially a loan companies or governments—the borrower—take out. Usually, the borrower pays interest to the bond owner until the bond matures and the principal is due. When interest rates go up, the cost of borrowing money generally increases, with borrowers making larger interest payments to the lender. Because new bonds will make the lender more money, reselling existing bonds that have an interest rate lower than the current market rate becomes more difficult. The bonds are often resold at a lower price to compensate for this difference. It’s worth noting that, provided the bond issuer doesn’t default, lenders who hold the bond to maturity will get their entire principal back. As with all investments, there are risks with securities such as bonds, including duration, credit, default, liquidity, and inflation.
While existing fixed-rate loans will not be impacted by rising interest rates, typically, rising interest rates can mean higher rates on new consumer loans. This can apply to everything from mortgages, to personal loans, student loans, and more.
While existing fixed-rate loans are not affected by changing interest rates, if you have an existing loan with a variable interest rate, that rate can change. The rate may go up as market interest rates increase and go down if market rates decrease. For consumers with variable-rate loans, rising interest rates can mean a larger monthly payment.
Generally, credit cards come with a variable interest rate. This means the interest rate can change along with market interest rates. To make things more complex, a single credit card can come with several different interest rates, including purchase APR (the rate that applies to purchases you make), cash advance APR (the rate that applies to a cash advance), and balance transfer APR (the rate that applies to a balance transfer), among others. If you carry a balance, the amount of interest you pay on this balance may increase with rising interest rates.
If you have a savings account or plan to put money into a certificate of deposit (CD), rising interest rates may mean that you’ll earn more interest on your money. If you have a savings account, you may see the rate adjusted automatically. Existing CDs have a fixed interest rate until the term ends, but new CDs will likely reflect the higher interest rate.
Keeping an eye on interest rates
Rising interest rates can affect consumers in various ways. Whether it’s credit cards, investments, earned interest, or a new loan, it’s essential to know the interest rate you’re agreeing to, understand the terms, and make sure you understand how interest rates will change the impact of your financial decisions.