The Federal Reserve has raised the benchmark interest rate four times in 2022, including 0.75% increases in both June and in July, and chances are interest rates may be on the rise again.
When the interest rate changes, there are real-world effects on how both businesses and consumers make purchases. To understand how interest rates affect your personal finances, you need to understand exactly how they work.
What Is an Interest Rate?
An interest rate is the price you pay to borrow money. Common examples include a mortgage, car or student loans or credit cards. When a lender loans money, they profit off of the interest paid. In the end, these rates will affect the overall price you pay once the loan is paid off. Because no two loans are exactly alike, it can be hard to decide which type of loan is best for you. Before you borrow, make sure you understand how the interest rate will affect your final payoff amount.
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Why Does the Federal Reserve Raise Interest Rates?
Interest rates are considered the Federal Reserve’s main tool for fighting inflation. The Fed can speed up or slow down the economy by moving interest rates lower or higher. When inflation is too high, the Federal Reserve will typically raise interest rates to help slow the economy and bring inflation down. When inflation becomes too low, the Federal Reserve lowers interest rates to stimulate the economy and help move inflation higher. By raising interest rates and, in turn, making purchases more expensive, the Federal Reserve is hoping to slow Americans’ willingness to spend money to combat rising inflation.
How Interest Rates Can Affect You
No matter your age, whether you are buying your first home or getting close to retirement, rising interest rates can affect you.
While the key interest rate is not tied directly to your mortgage rate, those looking to buy a home right now are hurting the most. Mortgage rates have been rising along with inflation all spring and summer. Look at a loan of $400,000 as an example of this increase. A few months ago, the payment on that loan would have been around $1,700 per month. Today, however, the payment has increased by almost $800. With this dramatic increase and rising prices for houses, mortgage applications are down nearly 15% from this time last year.
If you’re looking to purchase a home or a car and want to save money, try locking in a long-term loan rate as soon as possible before they increase even more.
If you’re past the days of purchasing new homes and looking toward retirement, interest rates could also be affecting you. Interest rates are not a direct influence on the stock market, but they can cause it to fluctuate. Rising rates do have a significant effect on bond portfolios. When the rates go up, the price of bonds goes down. Any long-term bonds you have can feel this impact significantly, while short-term bonds may be less impacted. Meanwhile, if you are considering an annuity, rising interest rates could be beneficial for you.
The Bottom Line
Having a diverse portfolio that includes stocks, bonds and cash equivalents is your best tool for maintaining growth through rising interest rates. Of course, before making any major investment decisions, meet with a financial adviser to discuss your options.
No matter whether interest rates are rising or falling, working with a financial adviser is always a good idea. From accumulating your retirement savings to planning your financial future, they are the experts. Don't be afraid to ask questions. It's your money, and they want to do what is best for you!
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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