How Does the Federal Reserve Interest Rate Affect Me?

Learn how to get an edge on your saving, spending and borrowing strategies when rates rise or fall.

The post How Does the Federal Reserve Interest Rate Affect Me? appeared first on Discover Bank - Banking Topics Blog.

Learn how to get an edge on your saving, spending and borrowing strategies when rates rise or fall.

You may not realize it, but behind the scenes the Federal Reserve is quietly influencing your everyday life when it comes to borrowing, saving and even spending. Serving as the central bank of the United States, the Federal Reserve, or Fed, is responsible for managing the country’s monetary policy. A big part of its job is adjusting the federal funds rate—the short-term interest rate banks charge each other to lend funds overnight. The Fed decides whether or not to raise or lower this benchmark interest rate in order to reach maximum employment and stable inflation.

OK, wait. Policymakers, the economics behind employment and inflation, overnight lending between banks… so how does a change in interest rate affect your decision to spend or save, you ask? To borrow from a popular saying: “So goes the federal funds rate, so goes consumer interest rates,” says Riley Adams, a certified public accountant and founder of personal finance website Young and the Invested. Whether it goes up or down, a change to the federal funds rate could have a ripple effect in the same direction for borrowers, savers and spenders—an important proof point for why the federal funds rate matters for consumers.

Are you wondering, "how does the Federal Reserve interest rate affect me?" A Fed rate change usually has a ripple effect in the same direction for savers, spenders and borrowers.

If this is news to you and the federal funds rate hasn’t really been on your radar, have no fear. What follows will help you more fully answer the question: How does the Federal Reserve interest rate affect me? Then you’ll be on your way to making the best money management decisions for your financial goals and the current interest rate environment.

A low interest rate environment makes borrowing more attractive

The answer to “how does the Federal Reserve interest rate affect me?” can be very beneficial in a low-rate environment if you have debt or are looking for new borrowing opportunities. When the Fed cuts rates, borrowing money tends to become less expensive since banks and lenders also typically lower rates on their credit products.

In a low-rate environment, for example, you could see lower rates on:

  • Credit cards
  • Auto loans
  • Personal loans
  • Private student loans
  • Home equity lines of credit
  • Adjustable-rate mortgages
  • Business loans

Why the federal funds rate matters for consumers and the credit cards in your wallet has to do with minimum payments and interest charges. A Federal Reserve rate cut could translate to a lower minimum payment on credit cards and a lower cost to carry a balance from one month to the next. For loans, a Fed rate cut could mean lower monthly payments and less interest paid out over the life of the loan. Lower borrowing costs can add money back to your budget that you could use to spend, save or apply to your financial goal of choice.

How does the Federal Reserve interest rate affect me when it comes to homeownership, you ask? There’s good news there, too. When the Fed lowers rates, homeowners with an adjustable-rate mortgage or homebuyers shopping for one may experience a rate reduction, since the rates for this type of mortgage typically track with the prime rate, which is in turn influenced by the federal funds rate. The lower your mortgage rate, the lower your monthly payment and the more home you might be able to afford. Good deal. Note that fixed-rate mortgages are less directly impacted by a Fed rate cut.

Chad Rixse, director of financial planning at Forefront Wealth Partners, says that when rates are falling, it may be a good time to consider refinancing or consolidating existing debt, such as private student loans, home loans and car loans. (Definitions: Refinancing means replacing your existing loan with a new one at a lower rate. Consolidating means paying off multiple loans with a single new loan.)

When analyzing “how does the Federal Reserve interest rate affect me?” Adams adds that consumers should be mindful of how much rates have dropped to determine the value of refinancing or consolidating. Using mortgages as an example: “They should not consider refinancing a mortgage after a 25 basis point (0.25%) cut in the rates because the associated costs and fees will outweigh any interest savings,” Adams says. “If rates move meaningfully lower (1.00%+), they should be on the lookout for refinancing offers, assuming they have significant time remaining on their mortgage and can benefit from lower interest costs.”

When rates rise, savers reap the benefits

How does the Federal Reserve interest rate affect me when rates go up? In a higher interest rate environment, your savings may actually be able to get a little more love.

“If interest rates rise, this benefits savers by possibly earning more interest on their bank deposits, assuming their bank indexes interest rates on deposits to remain competitive against other banks,” Adams says.

For your list of “ways the Fed interest rate affects me,” consider that these savings vehicles could earn more interest when rates rise:

  • Savings accounts
  • Certificates of deposit (CDs)
  • Money market accounts
  • Interest-bearing checking accounts

You can take advantage of higher savings interest rates and get the most from your savings efforts by increasing the amount of money stashed in your interest-earning savings accounts. The higher the balance, the more you will earn.

If you’re focused on saving and there’s a chance rates could drop in the near term, you may want to lock in a higher rate while you can with a long-term, fixed-rate CD. That way, you can continue to earn a higher rate throughout the CD’s term even if the Fed cuts the federal funds rate and rates start to drop on deposit accounts.

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Interest rates can affect spending habits

Why the federal funds rate matters for consumers even extends into purchasing power and everyday spending.

“By raising the federal funds rate, the Fed makes it more attractive for banks to hold extra capital,” says James McGrath, a housing market expert and licensed real estate broker at New York-based real estate firm Yoreevo. “When more money is locked away in vaults, there is less available to make loans and buy things, which slows growth and inflation.”

If inflation is kept to a minimum by the Fed’s benchmark interest rate, prices for things you buy every day—think groceries or personal care items—have less room to increase. If a Fed rate change keeps those everyday prices low, you can put more of your money toward savings or paying off high-interest debt.

Why does the federal funds rate matter for consumers? It can impact inflation and purchasing power.

On the flip side, McGrath says the Fed can lower rates to spur spending. That puts more money into the economy, but it does open up the potential for prices to rise, he says. If you’re wondering “what ways the Fed interest rate affects me?” consider that higher prices could mean that your money has to stretch further to buy the same things.

How to handle interest rate changes

By now, you should have a better understanding of why the federal funds rate matters for consumers. While there’s nothing you can do to control the Federal Reserve’s rate changes, you can control how you react to rising or falling rates.

Look at your overall financial situation against the backdrop of what’s happening with rates. Your list of ways the Fed interest rate affects me might be different than someone else’s. Ask yourself how you can take advantage of rising or falling rates for maximum financial benefit when it comes to your borrowing, saving and spending priorities. For example, if the Fed hikes rates and you’ve been building up a college savings fund for your children, you may be motivated to put more into savings to take advantage of higher returns. If rates are cut and you’ve been in the market for a loan for some time, now could be the time to jump on it.

Worried about the ways the Fed interest rate affects you? Remember it could take more than just one Fed rate change to make a significant impact on your daily life.

Note that the ways the Fed interest rate affects me may also depend on more than just one Fed rate change. “Small changes don’t amount to significant differences over time,” Adams says. “It’s when a long-term rate increase or decrease path becomes the norm that consumers should pay more attention,” he adds.

Above all, remember that rate increases and decreases are a normal part of what the Fed does. “Remain calm and carry on,” Rixse suggests. “Don’t let panic or negative emotions guide your decision-making.”


Source: discover.com