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In the context of the US economy, “interest rates” refers to the price of borrowing decided upon by banks, credit unions, and other financial institutions throughout the country.
Interest rates may vary by financial product or lender. However, many US financial institutions will calculate their interest rates partly by observing the federal funds rate—the price of short-term lending between banks—set by the Federal Reserve’s Federal Open Market Committee.
Changing interest rates are often a sign of a shift in broader economic trends. However, interest rates also have direct effects on your own daily finances, such as the APR on a car loan, current refinance rates, or how you save for retirement.
Let’s look at how interest rates can affect your personal finances through financial products like mortgages, credit cards, and savings accounts.
Why do interest rates change?
Primarily, the demand for credit between banks and government regulations directly causes changes to interest rates, though these factors are once again affected by changes to the federal funds rate, which shifts to accommodate two main priorities decided by the Federal Reserve:
Prices: The Federal Reserve wants to ensure that inflation remains stable.
Employment: The Federal Reserve wants to ensure maximum employment.
Since global and national changes to the market may cause shifts in employment or prices, the Federal Reserve may choose to change the federal funds rate to ensure stability in inflation and employment. This change causes US financial institutions to shift their interest rates accordingly.
Interest rates and mortgages
Raising interest rates is often meant to help reduce demand in the marketplace. It can also encourage consumer restraint when taking on larger lending products like mortgages, since these loans become more expensive as interest rates rise. Here are a few ways that interest rates affect housing:
Mortgage payments: If you have a variable-rate mortgage, your monthly payments could change when interest rates change.
Mortgage affordability: if you’re planning on taking out a mortgage, it may be more expensive to do so when interest rates are high.
Refinance rates: If you’re looking to refinance your current mortgage, interest rates will affect whether refinance rates are higher or lower than your current mortgage.
Interest rates and credit
You may also notice the effect of interest rates on consumer financial products such as car loans, personal loans, and credit cards. This is because interest rates play an important role in determining a loan or credit card’s APR. But interest rates and APR aren’t quite the same, even though they both play a role in determining your payments for loans or credit cards.
Interest rates vs. APR
While an interest rate is the cost you pay the lender for borrowing money, the annual percentage rate, or APR, is the interest rate plus additional fees charged by the lender, which might include origination charges or other fees levied at the time of the loan. With higher interest rates, you could end up paying more money over the life of your loan or on your credit card balance.
Interest rates and savings
When interest rates change, banks and credit unions may offer different yields on their savings products like high-yield savings accounts and CDs. You may be able to find more favorable yields at a time when interest rates are high and less favorable yields when interest rates are low, although APYs will vary depending on the type of product and financial institution you choose.
As interest rates change, you’ll want to keep track of how the yields on these savings products change over time as well. A shift in rates may lead you to opt for a different savings strategy, such as placing more of your funds in CDs or transferring funds from a CD to a savings account. As you do so, always be mindful of any transfer or withdrawal fees these accounts may charge.
Interest rates and investments
Interest rate changes can also affect the prices of investment products like bonds and stocks, as well as what kind of strategies investors might adopt to meet their financial goals. For example, a rise in interest rates will typically cause bond prices to lower since there will be less demand for fixed-yield products.
When interest rates decrease, older bonds will offer comparatively higher yields, and their prices tend to rise due to increased demand. Keep this in mind if you’re planning to make continual investment in bonds as a part of a long-term retirement or investment strategy.
How to handle interest rate changes
Any borrower, investor, or consumer who uses a financial product that hinges on interest rate changes should stay informed on how and when the rates change. Here are some quick tips to handle interest rate changes:
Research the rates through trusted sources: While the federal funds rate plays a major role in deciding interest rates, each financial institution may react to a change in rates differently. Always make sure to check interest rates set by your specific lender or bank.
Check your APR: Understand how interest rate changes may affect the APR on any outstanding loans, mortgages, or credit card balances. Stay as updated on these changes as you can and budget for them accordingly.
Check your retirement plan: If your retirement savings strategy involves investing in stocks, CDs, index funds, or bonds, you’ll want to pay attention to how interest rates can affect the yield of these investments. Shifting interest rates may require you to adjust your strategy.
Disclaimer: Article content is intended for information only. It may not reflect the publisher nor employees’ views. Consult a mortgage professional before making financial decisions. Publishers or platforms may be compensated for access to third party websites.
