What Do Rising Rates Mean for You?

Rising rates impact just about anyone who borrows or saves money, so it’s important to understand what's going on in this rising rate environment and what you can do to protect your finances.

Your quick takeaway:

• The Fed is the central bank in the U.S. They set the federal funds rate, which impacts interest rates on loans, credit cards and deposit accounts.
• Inflation in the U.S. is increasing quickly, meaning the price of almost everything is going up.
• The Fed has been raising its rate to help slow down inflation.
• As interest rates go up, loans get more expensive and savings accounts earn more interest.
• Borrowers may want to switch to fixed-rate loans and reduce their credit card debt to protect themselves from rate increases.

It Starts With the Fed

We don’t want to turn this into an economics lesson, so to put it simply, the Fed is short for the Federal Reserve, which is the central banking system for the United States. The Fed sets the federal funds rate, which determines how much it costs for financial institutions to borrow amongst each other. 

Why should we care? When the Fed changes the federal funds rate, it has a ripple effect on consumers. Financial institutions consider the Fed rate when establishing their own interest rates for loans and deposits, such as credit cards, home loans, car loans, savings accounts and certificates of deposit. There are a wide range of other effects on our economy as well – for example, the stock market reacts to Fed rate changes, inflation and the price of goods change, homebuying activity shifts, even insurance policy premiums change.

Why Are Rates Going Up?

Over the past year or so, inflation in the United States has been rising at a rapid pace, meaning it’s getting more expensive to buy things like food, gas, clothes, cars, houses and more. There are many complex reasons for inflation that we won’t get into now, but the general idea is the pandemic created a pressure cooker of production costs, supply chain issues and consumer demand.

When the Fed lowers the federal funds rate, interest rates go down and consumer borrowing and spending go up. However, when the Fed raises the federal funds rate (which is what’s happening now) it has the opposite effect – rates go up and consumer borrowing and spending go down. The theory is that by slowing down borrowing, inflation will also slow, and the price of goods will stop increasing so quickly.

How Do Rate Changes Affect You?

For savers

Some happy news! When it comes to deposit accounts, rising rates are a good thing, and your savings account should start earning more interest as rates go up. You might even want to shop around to see if any banks or credit unions are offering special promotions on high-yield savings accounts to earn even more from your savings.

For homebuyers

Homebuyers have not had an easy ride these past couple of years. House prices keep going up, and now rates are too. While home loan rates are still low compared to previous decades (rates in the 1980s were in the double digits), that’s a small consolation if you find yourself being priced out of buying a home right now.

If you are determined to buy a house, keep in mind that, because buying a home is such a large purchase, even small rate changes can have a big impact on your overall costs. For example, a $350,000 home loan with a 3% rate costs around $1,700 per month, while the same loan with a 5% rate costs around $2,100 per month. Over 30 years, that extra $400 per month adds up to $144,000! This makes it as important as ever to shop around and compare home lenders to find your absolute best rate. 

Although we won’t stay in a rising rate environment forever, you may want to avoid adjustable-rate mortgages (ARMs), which offer a lower introductory rate that can later go up or down. If you don’t like the risk or your budget isn’t able to handle a rate increase, you may want to stick with a fixed-rate mortgage. And if you’re a current homeowner with an adjustable-rate mortgage, now may be the time to refinance to lock in a fixed rate, before rates go up again.

For borrowers

Personal loans, car loans, credit cards – it’s all getting more expensive. You may want to avoid borrowing altogether if you can. However, if you must borrow, say to buy a new car, the best thing you can do is stay on top of your budget and make sure you don’t borrow more than you can afford.

If you have existing loans, it’s a great idea to double check that your rates are fixed and won’t go up. If you do have adjustable-rate loans (also known as variable-rate loans), ask your lender about refinancing them to a fixed rate.

The rates on credit cards and lines of credit are usually adjustable and change when the Fed rate changes, which means their rates are going up. If you carry a credit card balance, you may want to rethink your situation. Check out new credit cards that offer 0% balance transfers or consider getting a fixed-rate personal loan and using it to pay off your card balances. For homeowners with a home equity line of credit, you may want to convert your balance to a fixed-rate home equity loan.

For investors

Stock market fluctuations are nothing new, but they’ve been especially alarming as rates continue to rise. While every situation is different, your best bet is usually to avoid emotional reactions – don't make hasty decisions and instead remember that you are investing for the long term. Short-term ups and downs will happen, but don’t panic.

If you’re really concerned, or if you’re close to retirement and need to lower your risk, talk to your advisor (or get a second opinion from a new advisor) to make sure your portfolio is properly diversified to match your goals and time frame.

The Bottom Line

Rates are always changing. And since rate changes aren’t always easy to predict, your best bet is to stay informed and take smart steps to protect and strengthen your finances. Improve your credit score, pay off credit cards, avoid taking out more debt than you can afford, and make sure your savings is earning as much as it can.

It’s good advice not just for a rising rate environment but for anyone who wants to build their financial resilience.