Rising interest rates: What you need to know
May 6, 2022 • 5 min read
What we'll cover
What rising rates mean for you
How rising interest rates impact savers
How higher interest rates affect borrowers
What do higher interest rates mean for you and your family?
When it comes to money, consumers have experienced a lot of changes over the last two years from saving extra cash during the pandemic, to taking advantage of record-low mortgage rates, and experiencing rising prices at the gas pump. Now, as we home in on the second half of 2022, navigating higher interest rates has been added to the list and they could be here to stay.
The good news is that rising rates are usually a sign of a strong economy. When economic growth is firing on all cylinders, the unemployment rate is low (under 4%), and household finances are on solid footing, higher interest rates can be more easily absorbed. Additionally, interest rates can be used to combat high inflation, which is often a sign of an overheating economy. To help cool demand and lower prices, the Federal Reserve Board (the Fed) will raise interest rates, aka the Fed funds rate. These are all reasons why interest rates are moving higher this year.
Higher rates may impact you differently depending on your circumstance. There are several key implications to consider for savers and borrowers. Let’s look at it from both perspectives.
How do rising interest rates impact savers?
For savers, higher interest rates might be a welcome trend for a few reasons.
1. Earning more on savings accounts and CDs.
Typically, when the Fed hikes rates, banks will bump the yield they offer on short-term savings accounts and various Certificates of Deposit (CDs). Notably, not all banks respond in the same way to the changes in rates, and in general bank increases can lag the moves by the Fed. Higher interest rates earned on these “safe” accounts have been long awaited, but that doesn’t mean you should park all your money there. While interest rates are expected to continue to rise throughout the year, allowing you to make a little more on your cash, rates may not exceed 2-2.5%. That type of return won’t offset the inflation you’re experiencing in food and gas prices. And it is unlikely to make you rich. As such, these types of accounts are best used for money you may need to access quickly.
2. Stronger dollar = cheaper imports.
As mentioned above, when rates move higher it is a sign of the strength in the economy. When the economy is strong the dollar is typically strong. That makes it cheaper to buy things from abroad – whether it is wine, cheese or a fancy leather good. It also can make traveling abroad cheaper. When you arrive at your destination, your dollars will go a lot further when the dollar’s value outpaces the local currency.
How do higher interest rates affect borrowers?
Higher interest makes borrowing money more expensive. If you locked in lower rates earlier in the year (or even a few years ago), you’re likely in a good place by comparison – at least for a while.
1. Borrowing costs are up on mortgages.
During the pandemic mortgage rates fell to the lowest level on record. And lenders loosened their standards while interest rates were low. Many homeowners jumped at the opportunity to lock in these historic rates over the past couple years. Now that mortgage rates have been on the rise , don’t be hasty to refinance unless there are other circumstances guiding your decision (such as improvements in your personal credit). Keep in mind, borrowing costs are just one factor when it comes to buying a home. If you didn’t make the leap while rates were low, you still have options to build equity and refinance later when rates come down.
2. Credit card balances get more expensive.
Improving consumer credit scores has been a great trend in the last few years. Americans smartly used stimulus payments and other financial aid to bolster their financial situation. For those still struggling with credit card debt, though, times might get tougher. When market rates increase, credit card companies often charge higher rates on consumers carrying a balance. Here’s a tip: If you see the interest rate you’re being charged climb dramatically, call up your credit card issuer to try and negotiate a lower rate.
3. Small business owners could be pinched.
The pandemic ignited a surge in new business applications. Entrepreneurs seeking to grow their venture will likely face costlier financing. Higher borrowing rates will be particularly burdensome for small businesses since rising wages are already a major problem spot. If you are in this camp, take time to review your future borrowing needs and consider working with a CPA to determine what the best timing and approach should be for funding your future growth.
The trend of higher interest rates has its pluses and minuses. For savers and those potentially seeking overseas goods/travel, a gradual increase in market yields is a welcome change from the trend of the past decade. For borrowers, however, now is the time to revisit your plan for tackling your current debt and taking on new debt.
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