Interest Rates Are Rising, But Does That Impact Me?

The Federal Reserve System, commonly known as The Fed, recently raised interest rates in an attempt to regulate the increasing inflation rates the US has experienced. This most recent interest rate increase is suspected to be followed by six additional increases this year. While this has flooded news stories over the last several weeks, how does this impact us in the short-and long-term?  

What Does "The Fed" have to do with it?

In order to understand the impacts of interest rate increases, it's helpful to understand the role of The Fed. Three major components comprise the Federal Reserve System: The Board of Governors, Federal Reserve Banks, and the Federal Open Market Committee (FOMC). The FOMC is the Fed's monetary policymaking body and is responsible for overseeing open market operations. One of the overarching goals of the Committee is to achieve a 2% inflation rate over the long term; therefore, it influences the economic conditions by adjusting the federal funds rate. Reduction of the federal funds rate stimulates the economy while increases in the rate slow the economy down. 

What exactly is impacted by these interest rates?  

The recent rate hike will likely lead to increased interest rates for credit cardholders and borrowers with variable annual percentage rates (APRs). Most credit cards have variable interest rates related to the bank's prime rate (the interest rate that financial institutions charge their preferred customers). Increases in the federal funds rate make it more expensive for banks to borrow money. Therefore, the increased costs get passed on to the borrower. While a slight increase in the prime rate may have little impact on some borrowers, those who carry over large balances will see corresponding increases in the interest paid monthly.  

What about debt outside of credit cards?

The increase in the federal funds rate primarily impacts debt tied to variable interest rates. Auto loans, for example, are usually secured to a fixed rate; therefore, no change would occur in the cost of your existing fixed-rate loans. While the interest rate increase does not apply to any current debt with a fixed interest rate, available rates for new loans will increase. If you're in the market for a new purchase (ranging from a new or used car to a new home), consider that future available interest rates may be slightly higher than in past months due to current and likely future rate increases.

What should I do?

If you have debt with variable interest rates, now is an excellent moment to look for strategies to reduce your debt. While you cannot change the variable interest rate on your loan, restructuring your payments may allow you to decrease your overall debt. Those considering significant purchases in the near future should be aware that borrowing rates may be slightly higher than in recent years. With additional interest rate increases predicted in the near future, it may be advantageous to lock in a fixed rate sooner rather than later to save money over the life of the loan. Now, more than ever is the ideal time to be vigilant about your personal financial plan.