What happens when interest rates rise
What do higher interest rates mean to you and your family?
When it comes to money, consumers have seen many changes over the past two years, whether it’s saving extra money during the pandemic, taking advantage of record high mortgage rates or rising prices at the gas pump. Now, as we enter the second half of 2022, browsing with higher interest rates has been added to the list and they might be here to stay.
The good news is that increasing rates are usually a sign of a strong economy. When economic growth is in full swing, the unemployment rate is low (less than 4%) and household finances are strong, higher interest rates can be more easily absorbed. Additionally, interest rates can be used to combat high inflation, which is often a sign of an overheated economy. To help cool demand and lower prices, the Federal Reserve (the Fed) will raise interest rates, or the federal funds rate. These are all the reasons why interest rates are rising this year.
Higher rates may impact you differently depending on your situation. There are several keys consequences to consider for savers and borrowers. Let’s look at it from both angles.
What is the impact of rising interest rates on savers?
For savers, higher interest rates could be a welcome trend for several reasons.
1. Earn more on savings accounts and CDs.
Typically, when the Fed raises rates, banks increase the yield they offer on short-term savings accounts and miscellaneous Certificates of Deposit (CDs). Notably, not all banks react the same way to rate changes and, in general, bank increases can delay Fed moves. Higher interest rates earned on these “safe” accounts are long overdue, but that doesn’t mean you should put all your money there. While interest rates should continue to rise throughout the year, allowing you to earn a little more on your money, rates cannot go above 2-2.5%. This type of return will not offset the inflation you experience in food and gas prices. And it is unlikely to make you rich. As such, these types of accounts are best used for money you might need to access quickly.
2. Stronger dollar = cheaper imports.
As mentioned above, when rates rise, it is a sign of the strength of the economy. When the economy is strong, the dollar is usually strong. It makes it cheaper to buy things abroad – be it wine, cheese or fancy leather goods. It can also make overseas travel cheaper. When you arrive at your destination, your dollars will go much further when the value of the dollar exceeds the local currency.
How do higher interest rates affect borrowers?
A higher interest rate makes borrowing more expensive. If you locked in lower rates earlier in the year (or even a few years ago), you’re probably in a good place by comparison, at least for a while.
1. Borrowing costs are rising on mortgages.
During the pandemic mortgage rates fell to the lowest level on record. And lenders relaxed their standards when interest rates were low. Many landlords have jumped at the chance to lock in these historic rates over the past two years. Now that mortgage rates have gone up, don’t rush to refinance unless other circumstances guide your decision (such as improvements in your personal credit). Keep in mind that borrowing costs are just one factor when it comes to buying a home. If you didn’t take the plunge when rates were low, you still have the option of building up equity and refinancing later when rates drop.
2. Credit card balances are getting more expensive.
Improving consumer credit scores has been a big trend over the past few years. Americans have made smart use of stimulus payments and other financial aid to bolster their financial situation. For those still struggling with credit card debt, however, times could get tougher. When market rates rise, credit card companies often charge higher rates to consumers with a balance. Here’s a tip: if you find that the interest rate you’re being charged is going up significantly, call your credit card issuer to try to negotiate a lower rate.
3. Small business owners could be pinched.
The pandemic has triggered a wave of new business apps. Entrepreneurs looking to expand their business will likely face more expensive financing. Higher borrowing rates will be particularly constraining for small businesses since rising wages are already a major issue. If you’re in this camp, take the time to consider your future borrowing needs and consider working with a CPA to determine the best time and approach to fund your future growth.
The upward trend in interest rates has its pros and cons. For savers and those potentially looking for overseas property/travel, a gradual increase in market returns is a welcome change from the trend of the past decade. For borrowers, however, now is the time to revisit your plan to tackle your current debt and take on new debt.
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Lindsey Bell, Chief Markets and Money Strategist at Ally, is an award-winning investment professional with a passion for personal finance and over 17 years of experience on Wall Street. Bell’s unique ability to connect the dots between data and real life and create small money ideas that people can use and apply stems from her deep experience as an analyst, researcher and portfolio manager. in organizations such as JP Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors of all backgrounds and frequently shares her insights with The Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also sits on the board of Better Investing, a non-profit organization focused on investment education.
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