What Does a Rise in the Fed Funds Rate Means?

Susan Kelly

Dec 29, 2022

The Federal Reserve kept interest rates low for the first two years of the COVID-19 epidemic, but on December 14th, they announced their seventh rate rise, lifting them by 0.5 percentage points. This is followed by price hikes in December, January, February, March, and April.

This indicates that rates on common financial products such as savings accounts, mortgages, and credit cards may increase. Because interest rates have been so low for such a long period of time, many consumers, especially members of the millennial and Gen Z generations, hadn't experienced a time when it wasn't inexpensive to borrow money and savings vehicles didn't pay almost nothing on deposits.

The federal funds rate is the sole rate that the Federal Reserve may change. This rate establishes the cost at which financial organizations borrow funds from one another for one day. A rise in the funds rate by the Federal Reserve has a direct impact on the interest that customers pay when they carry a balance on their credit card or take out a loan, as well as on the yields for savings accounts and certificates of deposit, among many other rates throughout the economy.

In general, the Federal Reserve will attempt to boost the economy by lowering interest rates and attempting to head off inflation by increasing interest rates. If interest rates continue to climb, the following is what you may anticipate, as well as advice on how to position your money.

Higher Returns for Savers

When interest rates rise, it's excellent news for savers who save money but terrible news for those who borrow money. Investors have seen meager returns in recent years, particularly from their savings accounts. The performance of certificates of deposit has remained relatively high. Many savers who save money have been able to eke out interest from accounts by searching for higher-yield savings accounts and higher-yield CDs, both of which give greater yields than regular bank accounts.

The historically low-interest rates offered by savings products will likely stay the same. Still, a hike in the federal funds rate may drive competition among banks and credit unions, which may be to the advantage of customers. If your financial institution is sluggish to react to a rate hike by the Federal Reserve, it may be worthwhile to seek a savings account with higher rates elsewhere, particularly at an online bank or credit union that operates online. After a rise in the federal funds rate, the finest high-yield savings accounts are often among the first to boost the returns on their deposits.

More Expensive Debt

Since the interest rates charged by credit card companies are often variable, they are particularly susceptible to shifts in the federal funds rate. If you hold a balance on your credit card, your interest rate and the amount you are required to pay each month will likely increase. Because of this, it will be more difficult to pay off the loan. However, there are actions you may do to lessen the impact of the ever-increasing interest on your credit cards.

Regardless of what happens with interest rates, you should prioritize making significant progress in paying off your credit card debt. You need to reevaluate your spending habits to see whether or not you can find any extra money to put toward reducing the balances on your credit cards. You should also consider whether or not you can raise your income, even if just temporarily.

Make certain you meet at least the minimum payment requirements on time for each credit payment, even if interest rates continue to climb. This will, over time, help build your credit score, making it simpler for you to qualify for loans with lower interest rates.

If you have decent credit, consider transferring higher-interest debt to a credit card that allows balance transfers. These deals may become more difficult if the Federal Reserve continues to boost interest rates. Securing a 0% introductory APR for at least a year is an excellent method to make a large dent in your debt load. Your credit score also increases if you pay off your accounts early and in full.

Impact on Home Buyers

In 2022, mortgage rates have increased before each rate hike by the Fed, including this one, and it is expected that they will increase much more through the rest of the year and into the following year.

Because the Federal Reserve decided to raise interest rates, an extended period of record-low mortgage rates ended. This was partly caused by the fact that the federal funds rate was so close to zero for around two years. As the market is more aware of the Fed's plans in January, these rates shot up by about half a percentage point. Even after that first uptick, mortgage rates remained at historically low levels in comparison to those experienced by earlier generations of homebuyers.

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