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What Does a Fed Rate Hike Mean for Your Money?
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The Federal Reserve raised the benchmark federal funds rate today, this time by 25 basis points to a new target range of 4.50% to 4.75%. This was the eighth straight meeting in which the U.S. central bank raised rates to fight sky-high inflation.
Why does the Fed raise interest rates?
The Fed hopes that by raising interest rates — which makes it more expensive for consumers and businesses to borrow money — it can decrease demand and restore price stability.
Tightening monetary policy by increasing rates runs the risk of causing a recession and hurting a strong job market, but the Fed has argued that the risks of sustained inflation are more serious.
At the start of the COVID-19 pandemic, the Fed slashed rates to zero as part of a broader fiscal and monetary stimulus strategy to prevent long-term economic damage. The plan worked, as the U.S. avoided the worst-case scenario. The job market quickly recovered, households were able to save money and an effective vaccine helped bring life back to normal.
However, an imbalance between low supply and high demand has created upward pressure on prices across the economy. The pandemic, as well as Russia’s invasion of Ukraine, has impacted shipping, labor, energy and commodities markets. Meanwhile, there’s been more competition among consumers to purchase goods and services and more competition among businesses to hire and retain workers.
Together, those dynamics have caused prices to rise significantly, according to Consumer Price Index (CPI) data. Raising interest rates will decrease demand and hopefully cause prices to fall, but a probable recession looms over the horizon.
What to do when interest rates rise
So what does a Fed rate hike mean for you?
“Expect to pay more on the interest charges from your credit card company, and auto loans and mortgages will also become more expensive,” says Ken Tumin, LendingTree’s senior banking industry analyst. “On the flip side, we can generally expect banks to raise their savings account rates when the Fed increases its benchmark rate.”
Here’s how to prepare for rising interest rates.
Pay down your credit cards
Your credit card interest rate is likely to go up within a month or two of this news. If you’re carrying credit card debt, this means your monthly payments will grow and you’ll be paying more in interest — costing you a lot more money.
If you currently have credit card debt, consider making bigger and more frequent payments to pay it off more aggressively. Signing up for a 0% interest balance transfer credit card or getting a debt consolidation loan could be another option to protect you from paying more interest, at least in the short-term. Looking to open a new card altogether? A card with an intro 0% annual percentage rate (APR) offer can shield you from fluctuating interest rates for a while.
Lock in your mortgage rate
Mortgage rates are at their highest in over 20 years. But if you already have a fixed-rate mortgage, don’t worry — your interest rate will stay the same.
Costs for aspiring homeowners may increase, though. “Mortgage rates could trend up over the next few weeks,” says Jacob Channel, senior economic analyst for LendingTree, but “there’s no guarantee that mortgage rates will change all that drastically. Remember that while the Fed’s actions do impact mortgage rates, it doesn’t directly set them. With that said, rates on products like home equity lines of credit (HELOCs) and adjustable-rate mortgages (ARMs), which are pegged to the prime rate, will increase.”
If you’re looking to buy a home or refinance a mortgage, don’t stress about rates. “While mortgage rates are important, obsessing over them too much is liable to do more harm than good,” Jacob says. “If you’re in a place right now where you can afford to buy a home without becoming excessively cost burdened, then you shouldn’t worry too much about whether or not rates could eventually come down.”
Set your auto loan rate
Like mortgage rates, auto loan rates can go up with Fed rate hikes while lenders adjust to the new federal funds rate. Refinancing terms also become less favorable in an environment of rising rates. Locking in a lower rate now may help ensure you’re spending less money on interest and getting the best value on your car purchase.
If you’re planning on buying a new or used car, pay attention to the APR and move fast if you want today’s rates. With the federal funds rate continuing to rise, the interest rates on new auto loans could rise as well.
Grow your savings
There’s some good news when it comes to the Fed raising interest rates: savings and other deposits earn more interest. “Deposit rates are reaching highs not seen in more than a decade,” says Ken. “Further deposit rate increases are likely as the Fed continues to hike rates.”
But be sure to shop around for the best rates, because not all banks will pay you more. “Many banks have been slow with rate increases as their deposit levels have remained high,” says Ken. “To benefit from the higher interest rates, you may have to move your money to those banks which are willing to pay higher savings account rates.”
Look for a high-yield savings account — online banks will probably be your best bet — to ensure you’re getting a competitive rate. You may also find a certificate of deposit (CD) or an I bond to be a good option when it comes to protecting the value of your long-term savings. They have higher rates, but you’ll need to sacrifice some short-term liquidity.
Prepare for student loan repayment
The Supreme Court will hear challenges to President Biden’s student loan forgiveness program this year. The federal student loan payment pause will end 60 days after the program is permitted to begin or litigation is resolved. If neither has happened by June 30, 2023, then payments will resume 60 days after that date.
“If it’s been a while since you’ve made a federal student loan payment, you might want to log into your account at studentaid.gov and check how much you still owe, after any forgiveness you might qualify for,” says Michael Kitchen, student loan managing editor at LendingTree. “If you think you’ll have difficulty keeping up with repayment when it restarts, talk to your servicer about your options — especially income-driven repayment plans.”
Rising interest rates won’t impact existing federal loans, which have fixed interest rates, but could make future student loans more expensive. If you have fixed-rate private loans, those rates won’t change either, but the rate on variable-rate loans will very likely rise. Student loan refinancing may become less common as interest rates rise, but the terms for private, refinanced loans could become less favorable moving forward due to rising rates.
What’s next for the Fed and the economy
The path of future Fed rate hikes depends on whether progress has been made in bringing inflation down. The Fed considers a wide range of economic data points, including CPI and Personal Consumption Expenditure (PCE) inflation, as well as more specific price data. Unless the Fed sees evidence that price increases are subsiding in a meaningful way, the Fed will probably keep raising rates.
In recent meetings, Chairman Jerome Powell has acknowledged that raising rates will cause an increase in unemployment. It’s likely that millions of Americans will lose their jobs during this tightening cycle as the demand for workers decreases and a strong labor market weakens. Powell has argued that labor market strength cannot exist in the long run without price stability, so the Fed is willing to tolerate that pain in its effort to slow down inflation.
Frequently asked questions
How does raising interest rates help inflation?
The Fed raises interest rates to slow the amount of money circulating through the economy and drive down aggregate demand. With higher interest rates, there will be lower demand for goods and services, and the prices for those goods and services should fall.
Did the Fed raise interest rates?
Yes, the Fed raised the federal funds rate at its last meeting in February. While the Fed doesn’t directly control the rates at which banks lend to consumers and businesses, the federal funds rate, which determines the rate at which depository institutions lend each other money, affects those rates.
When is the next Fed rate hike?
The Fed could raise interest rates again at its next meeting, which is scheduled for March 21-22. Until the Fed sees price indexes start to show inflation falling significantly, rate hikes will likely continue, and the federal funds rate will remain elevated.