What a Fed Rate Hike Means for Borrowers, Savers and Home Buyers
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Action items when interest rates are rising:
Shop for a higher-yielding online savings account to take advantage of higher rates.
Pay down your credit card debt; consider a balance transfer credit card.
If you're shopping for a home, make sure your mortgage preapproval reflects current interest rates.
The Federal Reserve ended its short pause in interest rate hikes, announcing a quarter-point increase at its July meeting. That means consumers may again see higher rates on familiar financial products like savings accounts, mortgages and credit cards.
Until fairly recently, interest rates had been low for so long that many consumers — millennials and Gen Z, particularly — hadn’t really known a time when borrowing wasn’t cheap and savings vehicles actually earned interest.
Strictly speaking, the Fed can change only a single rate: the federal funds rate. This rate determines how much interest financial institutions charge one another to borrow money overnight. But because so many other rates in the economy are tied to the funds rate, any increase by the Fed has a direct effect on the interest consumers pay when they carry a credit card balance or take out a loan, and on yields for savings accounts and certificates of deposit.
In general, the Fed reduces rates to try to stimulate the economy and raises rates to try to head off inflation. Here’s what you can expect, and how to position your finances in a rising-rate environment.
Higher returns for savers
In general, higher interest rates are good news for savers and bad news for borrowers.
Interest rates on some savings accounts, in particular, have increased nearly tenfold over the past year. A year ago, even the best rates were hovering around 0.50% annual percentage yield, but the best rates have increased, with many topping 4% APY now. Certificates of deposit have seen exceptionally high rates, even 5% APY on some of the best 1-year terms. Many savers can benefit considerably by shopping for higher-yield online savings accounts and high-yield CDs, which tend to offer better returns than traditional bank accounts.
The rates on savings products don’t jump higher overnight when the Fed announces a rate hike, but a higher federal funds rate can stimulate competition among banks and credit unions, and consumers may benefit from that. Rates at some of the largest national banks are still paltry, with next-to-zero APYs, so it may be worth looking for a savings account with better rates, especially at an online bank or online credit union, if your financial institution is slow to respond to a Fed rate increase. The best high-yield savings accounts tend to be among the first to raise their yields after a federal funds rate increase.
More expensive debt
Interest rates on credit cards are typically not fixed, so they’re especially vulnerable to changes in the federal funds rate. If you’re carrying credit card debt, you can probably expect your interest rate — and also your minimum payment — to rise if the fed funds rate goes up. That will make it harder to chip away at the debt.
But there are moves you can make to take the sting out of climbing credit card interest.
Reducing your credit card debt aggressively is a good idea no matter what rates do. Re-evaluate your budget to see whether you can free up any cash to pay down your credit card balances, and think about whether you can increase your income, even temporarily.
As interest rates rise, ensure you’re making at least the minimum payments on time, on every card. This will help strengthen your credit score over time, which will make it easier to qualify for lower-interest loans.
If you do have good credit, consider moving higher-interest debt to a balance transfer credit card. These offers may become scarcer if the Fed continues to raise interest rates, and locking down a 0% intro APR for 12 months or more is a great way to make a significant dent in your debt. Paying down your balances will also improve your credit score.
If you plan to borrow money in the near future, you can expect to see higher interest rates on auto loans and personal loans. Double-check that your existing loans have a fixed interest rate, and consider borrowing sooner rather than later to keep your interest costs down.
If you own a home, you may be able to borrow equity to pay off your credit cards. But be careful — home equity lines of credit, which often have variable interest rates, will also be affected by Fed rate hikes. But if you want to use some of your equity without changing the interest rate on your primary mortgage, a HELOC or a home equity loan may be your best bet. For homeowners who bought or refinanced while rates were at historic lows, a cash-out refinance that comes with a significantly higher interest rate just doesn't make sense.
Impact on home buyers
Mortgage rates had already crept upward ahead of the Fed's 25-basis-point increase announced at the July meeting. Rates on 30-year fixed-rate loans have hovered close to 7% throughout the summer.
The Fed has indicated that it will likely raise rates at least another 25 basis points, but that could change depending on economic data. If investors think the Federal Reserve is backing off from hikes, that would relieve the upward pressure on mortgage rates. Barring any changes in forecasts, though, mortgage rates could rise if markets anticipate that the next hike will come at the Fed's September meeting.
The Fed exerts influence on mortgage rates, but indirectly. Financial markets set mortgage rates, which are influenced by the inflation outlook — and markets are increasingly convinced that inflation is headed downhill.
This year's home buyers confront an obstacle: Not enough homes are for sale to meet demand. The shortage is blamed partially on "rate lock-in," in which homeowners with low mortgage rates keep their homes off the market because they don't want to pay higher interest rates on their replacement homes.
Given how much interest rates can change the math of your homebuying budget, make sure to keep your mortgage preapproval up to date. You don't want to make an offer on a home only to find out that it's out of your price range at the current interest rate. You might also consider buying a mortgage rate lock to ensure your rate doesn't increase before your home purchase closes.
A rising rate environment
Reducing debt, especially when you’re paying a variable interest rate, will help you in a rising-rate environment. So will increasing your savings and staying focused on your long-term investing strategy, in spite of day-to-day fluctuations in the stock market.
