The better your interest rate, the more opportunity your money has to grow. So it’s natural to wonder how changes in the Federal Reserve’s interest rate policy may impact you on a personal level. Specifically, you might be concerned with how your savings goals may be affected if rates change, as they have done recently.
So what’s happening with your money and what are your options?
Here are the key things to keep in mind about interest rate changes in case you’re not all that familiar with how they work.
How the Federal Reserve sets interest rates
The Federal Reserve (or Fed, for short) is the central bank of the United States and is responsible for setting the federal funds rate. This is the rate at which banks lend money to one another.
To determine the rate paid on deposits, banks and other financial institutions will consider the level of the Fed funds rate, as well as other factors like the current and anticipated rate environment, rate movement from other banks, consumer demand for loans and deposits, and the short and long-term economic outlook.
In other words, the federal funds rate plays an important role in determining the rates on the accounts you may use as part of your savings strategy, but it’s not the only factor. Each bank uses a rate strategy that supports its unique business model and that’s why the rate on savings products can vary so greatly from one bank to the next.
When the Fed makes changes to the federal funds rate — either raising it or lowering it — it’s typically done as part of a broader strategy to manage U.S. economic growth. In a strong economy, for instance, the federal funds rate may be increased to keep prices level and try to avoid the potential for inflation.
On the other hand, the Fed may lower interest rates to spur economic growth. The idea is that by lowering rates, borrowing becomes less expensive since banks also lower rates on loans (like home mortgages) and credit cards. That can help put money back into the economy as consumers borrow and spend more.
One side effect? When the federal funds rate drops, banks charge less to borrow, but they also lower the amount they pay out in interest to savers to help keep their businesses in balance.
What lower (or higher) rates mean for your savings
At first glance, an interest rate decrease may seem concerning. After all, it means you’re earning less money on your savings.
But, it’s helpful to keep a rate decrease in perspective. A .10 percent decrease in annual percentage yield (APY) translates to a difference of just one dollar less earned in interest over the course of a year for every $1,000 in savings.
As you plan your savings strategy, it’s important to remember that the APY on a savings account can fluctuate at any time, but you can access your money at any time without penalty. In contrast, the APY on a CD is fixed for the duration of its term, but your funds are locked up and you could incur a penalty if you make an early withdrawal from your account. As a result, CDs typically have APYs that are higher than those on savings accounts.
It’s also important to remember that rate decreases may work in your favor in other areas of your financial life. Buying a home or refinancing a mortgage, getting a personal or business loan or opening any other line of credit may be less expensive when rates drop.
What’s next for interest rates?
This is a difficult question to answer, as the Federal Reserve’s stance on raising or lowering rates can shift over time. The Fed looks at the entire economic picture, including job growth, wages, inflation and the health of the global economy when making rate decisions.
For individuals, it’s important to remain aware of the potential for rate hikes or cuts and understand what it may mean for your overall finances, including your savings.
Knowledge is empowering and our goal is to make sure you’re as informed as possible. At the end of the day, we want you to feel confident in making the right decisions about where to keep your money when interest rates are on the move.
- What do you do when interest rates decrease?
- How have you taken advantage of lower interest rates?
- Do you pay close attention to interest rate movements?
Originally published August 2019