7 Steps That Protect You From Rising Interest Rates

7 Steps That Protect You From Rising Interest Rates

How Rising Interest Rates Can Ruin Your Life

By Kimberly Amadeo  Updated October 31, 2019

The Federal Reserve raised its benchmark fed funds rate to 2.5% at its December 19, 2018 meeting. Since then, it's lowered the rate three times. As of October 30, the current fed funds rate was 1.75%.

The fed funds rate affects all other interest rates. It directly affects rates for savings accounts, certificates of deposit, and money market accounts. Banks also use it to guide short-term interest rates. These include auto loans, credit cards, and home equity lines of credit. It also includes adjustable-rate loans.

The Fed's rate decision indirectly affects long-term rates as well, such as fixed-rate mortgages and student loans. It's one of the most critical factors in determining interest rates.

The lack of a Fed rate hike means banks won't pay you higher interest on your savings, but they also won't charge you more for loans. It affects wages and consumerism as well.

History

The Fed increased the federal funds rate a walloping 17 times between June 2004 and June 2006. Mortgage rates initially plummeted, but then they started to come back up. Ultimately, they were higher in June 2006 than they were two years earlier. Sometimes it can take 18 months for a fed rate hike to completely work its way through the economy.

The December 2018 increase was the fourth that year, and the ninth in the last two years. The chart below illustrates the changing Federal funds rate from 2000 through today.

The Effect on Everyday Life

The demand for products and services increases when consumers have more money. That happens when they can borrow money at reasonable rates. Think of that pricey new car you want and the auto loan you'd be able to take out because rates are currently low. But there's a flip side. As rates rise, that car might be less pricey because loan costs will rise. An increase in the Fed's rate tends to keep prices more stable.

The opposite occurs when rates are high. The real estate market could soften in 2019 as higher mortgage rates make home loans more expensive.

The economy becomes sluggish when the federal funds rate is high. As a result, companies cut back on hiring. Employees become trapped at the pay rate they're currently receiving because raises and incentives are likewise curtailed. But the Fed believes that curbing inflation is worth it.

Savings Accounts, CDs, and Money Markets

Banks base interest rates for all fixed income accounts on the London Interbank Offer Rate (Libor). Libor is a few tenths of a point above the fed funds rate. It's the rate banks charge each other for short-term loans.

Fixed income accounts include savings accounts, money market funds, and CDs. Most of these follow the one-month Libor. Longer-term CDs follow longer-term Libor rates.

The rates in the Libor history compared to the fed funds rate might show that they trend along a similar path, but this hasn't always been the case, particularly in 2008 and 2009 when the two diverged during the recession.

Credit Card Rates

Banks base credit card rates on the prime rate. It's typically three points higher than the fed funds rate.

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https://www.thebalance.com/how-fed-rate-hike-affects-you-4119767