The federal funds rate has already increased twice in 2017. On the surface, that might not sound like something that would affect your wallet. But it does. Here’s why you should care.
The federal funds rate is the interest rate that banks and credit unions charge for overnight loans to other banks and credit unions. More importantly to everyday consumers, it also helps determine the interest rates you pay on credit cards, auto loans and more.
The Federal Reserve is the central bank of the U.S. It shapes the nation’s monetary policy, regulates banks and helps keep the country’s financial system stable. As part of this, its interest-rate-setting body, the Federal Open Market Committee, meets eight times a year to discuss whether the federal funds rate should be changed. But according to a new NerdWallet survey, almost 1 in 8 Americans (12%) don’t know what the Federal Reserve is, and many more may not realize how these rate changes affect them. Only 42% say they would care if the Fed increased the federal funds rate.
NerdWallet commissioned a survey of more than 2,000 U.S. adults in August 2017, conducted online by Harris Poll. We asked about their financial priorities, how they feel about the prospect of future Fed rate hikes and the adjustments they’d make in preparation for rate increases. Here’s what we learned:
- The percentage of Americans who care if the Fed raises the federal funds rate increases with household income. More than one-third (35%) of those surveyed who make less than $50,000 a year say they care, compared with over half (54%) of those who make $100,000 or more.
- Fewer Americans think individuals in higher tax brackets, rather than lower tax brackets, are most impacted by federal funds rate increases. While 37% think individuals who make $37,951 to $91,900 are most impacted, only 8% think individuals who make more than $1,000,000 annually are most impacted.
- About two-thirds of survey respondents (65%) say they follow the Fed meetings’ outcomes or decisions. But more than 2 in 5 people surveyed (43%) say they’re not sure they would care if the Federal Reserve increased its target for the federal funds rate.
- Forty percent of survey respondents say they don’t feel very secure in their current financial situation
So why should Americans care about a rising Fed rate? Because it can affect their financial priorities. Almost 9 in 10 Americans surveyed (87%) have financial priorities. The most common goals are to start saving or save more for an emergency fund (42%), grow savings account balances as quickly as possible (40%) and pay off credit card debt as quickly as possible (38%).
The highest financial priority varies by generation. Millennials (ages 18-34) and Gen Xers (ages 35-54) are most concerned with starting or saving more for an emergency fund (52% and 48%, respectively). The top priority for baby boomers (ages 55 and older) is paying off credit card debt as quickly as possible (36%). Both of these financial priorities — and others — can be impacted by the rising federal funds rate.
Fed rate hikes can affect all consumers
More than 2 in 5 Americans surveyed (43%) say they’re not sure they would care if the Federal Reserve increased the federal funds rate. Meanwhile, almost two-thirds (65%) say they follow Fed meeting outcomes or decisions at least rarely, if not more often. That means some of those who pay attention to the Fed’s moves aren’t sure what those decisions could mean for their finances.
The percentage of Americans surveyed who would care if the Fed raised the federal funds rate increases with household income. Thirty-five percent of those who make less than $50,000 a year say they would care, compared with 54% of those who make $100,000 or more. That said, nearly 2 in 5 Americans surveyed (37%) tend to think that people in the $37,951 to $91,900 tax bracket are most impacted by such a rate hike.
In fact, Americans at all income levels can be affected by rate increases. Here’s how:
Savings: For Americans focused on saving cash for emergencies or growing their savings account balances as quickly as possible, a Fed rate hike won’t make too much of a difference right now. However, rate hikes impact banks’ annual percentage yields over the long term. This is especially true for online banks, which tend to have higher APYs than traditional financial institutions.
Investments: Expected rate hikes generally are baked into the market in advance, so surprises are what can really shake things up. Even so, long-term investors shouldn’t be concerned about short-term volatility. If a rate hike sends the market down, it can be a good opportunity to buy in at a discount. Otherwise, use these Federal Reserve meetings as a reminder to check your asset allocation and see if your portfolio needs rebalancing.
Credit cards: People who prioritize paying off credit card debt are smart to do so in the face of future Fed rate hikes. Most credit card interest rates are variable and are set by the prime rate, which is directly affected by the federal funds rate. So as the federal funds rate increases, so does the cost of credit card debt.
Mortgages: Homeowners with home equity lines of credit will likely see their interest rate move higher immediately after each federal funds rate hike. Adjustable-rate mortgages will likely rise as well, but ARM rates reset periodically, so you won’t see a higher rate until your next adjustment period. Homeowners with fixed-rate loans don’t have to sweat these rate hikes; their rate is locked for the life of the loan. For home buyers watching fixed mortgage rates, those loans may not be affected immediately but could rise on expectations of future federal funds rate hikes.
Student loans: Student loans technically aren’t affected by the federal funds rate. Instead, variable student loan interest rates usually are based on the London Interbank Offered Rate. But the LIBOR and the federal funds rate tend to move together, so when the Fed rate goes up, the LIBOR usually does the same.
Auto loans: Car loan interest rates aren’t affected directly by the federal funds rate, but they do tend to follow it. So as the Fed increases rates, auto loan rates are likely to creep up as well.
Consumers can combat rising rates
Two in 5 Americans surveyed (40%) don’t feel very secure in their current financial situation. Boomers are most likely to feel very secure about their finances compared with millennials and Gen Xers (70% versus 57% and 52%, respectively).
Knowing the Fed has increased the federal funds rate twice this year, more than half of Americans surveyed (52%) say they would do something differently with their finances in the face of another rate hike in 2017.
Of those who would do something differently, 56% would pay down credit card debt more quickly, 50% would shift their spending habits to rely less on credit cards, and 16% would try to secure a fixed-rate mortgage when looking to buy a home. Here’s how Americans can change their finances to combat a rising federal funds rate.
Despite millennials being the least likely to ever follow Federal Reserve meeting outcomes or decisions (50%, compared to 65% of Gen Xers and 75% of baby boomers), they’re the most likely to do something differently with respect to their current financial situation knowing the Fed has increased the federal funds target rate twice to date in 2017 and is expected to increase it again before the end of the year (65%, compared to 58% of Gen Xers and 38% of baby boomers).
Savings: One way to take advantage of rising interest rates is to choose a high-yield savings account and save more cash. Online banks tend to have some of the highest interest rates, and you can expect APYs to climb as the federal funds rate does.
Whether you’re saving money for emergencies or another financial goal, now is the time to do it. Interest rates have been at historic lows for years, and as interest rates go up, your savings will grow faster.
Investments: Long-term investors shouldn’t react to short-term market movements. Instead, view a rate hike and any subsequent market turbulence as an opportunity to make the money you invest go further. When stock prices are down, you may be able to buy more for less. If you plan to pay off debt in response to rising rates, consider whether removing those debt payments from your budget would free up additional money to save and invest.
Credit cards: Most credit cards have variable and double-digit interest rates, so if you have credit card debt, pay it off as soon as you can. Check out NerdWallet’s tips on how to pay off debt to eliminate your high-interest balances.
Mortgages: Homeowners with fixed-rate mortgages don’t have anything to worry about because their rates won’t change. Those with adjustable-rate mortgages should watch mortgage rates and consider converting to a fixed rate. If you’re looking to buy a home, a federal funds rate increase shouldn’t deter you. With rates still at historic lows, there’s no point in delaying your purchase, because rates are expected to move higher over time. There’s no better way to hedge against future rate increases than by locking in a long-term fixed-rate loan.
Student loans: If you have federal student loans, you probably have fixed rates that won’t change with Fed rate hikes. However, if you have private, variable-rate loans, you could see changes as the LIBOR increases. Limit the amount of interest you pay by accelerating your payment plan or refinancing your loans at a lower, fixed rate. Fixed rates won’t change and therefore won’t be affected by future Fed rate hikes.
Auto loans: Like mortgage rates, auto loan rates are still very low for consumers with good credit. If your credit score is in good shape and you’re ready to buy a car, you may want to do so before rates increase. If your credit needs work, the best thing you can do to save money on interest is to improve your credit score.
The increasing federal funds rate can impact many Americans’ financial goals. But with smart money moves, you can combat the effects and get your finances in better shape. Pay attention to the Federal Reserve’s decisions and use the increasing rates as a reason to grow your savings, pay off debt and refinance loans.