The ups and downs of interest rates: How rate moves may affect your money
What do interest rate changes mean for your financial goals?
Understanding why interest rates move and how they affect your financial life—especially in the current economy—may help you with your decision making.
Get to know the Federal Reserve
The Federal Reserve, or Fed, is in charge of money and banking in the United States. One of the Fed’s main jobs is making sure the U.S. economy stays on track. They do that by adjusting interest rates—or rather, one specific interest rate called the federal funds rate. That’s the rate that banks charge each other to borrow money for short amounts of time, usually overnight.
The federal funds rate doesn’t directly affect most people, but you still feel its pull because it influences another rate called the prime rate—the prevailing rate that banks charge their customers. When the Fed changes the federal funds rate, the prime rate typically moves in the same direction. And the prime rate is a reference for everything from bank deposits and loans to credit cards and adjustable-rate mortgages.
Interest rates and your money
When the Federal Reserve changes the federal funds rate, the effects move through the financial system. This can trickle into areas of your own personal finances, impacting how much interest you pay on loans or credit card rates, and how much interest you receive from savings accounts or earnings in investment portfolios.
“One of the main places that people will feel the effects of the Fed changing interest rates is in car loans,” says Stanley Poorman, CFP®, a financial professional with Principal®. “Most people need a car, but can’t pay cash to buy one, so they take out a loan. And since car loans are typically for 5 years or less, they’re influenced by the prime rate.” As interest rates go up, the money you borrow for a car or other type of loan becomes more expensive because of the extra interest you have to pay.
“If you’re trying to factor a car payment into your budget,” Poorman says, “higher rates tend to mean you’ll be able to afford less car than if rates were lower.”
When rates go down, the opposite is true, and your money may go a bit further. But Poorman suggests being careful about overextending yourself financially even when rates are low. “Don’t just consider interest rates when making financial decisions,” Poorman says. “It can be easy to take on too much debt just because a low interest rate makes it look affordable.”
Poorman has some other suggestions about interest rates and your finances.
- Rate changes typically take time to make a large impact on your wallet. If you hear the Fed is changing rates, don’t feel like you need to react immediately.
- Even if the Fed is changing interest rates, not all rates are affected equally. Longer-term interest rates—like fixed-rate mortgages—are less affected by changes to the federal funds rate and more affected by the overall U.S. economy.
- Creating a balanced mix of investment options in your portfolio may help you minimize any impacts when markets react negatively to news of rate changes.
- When interest rates increase, it may mean more money back for you through traditional savings options. However, the effects will probably be minimal.
- Interest rate changes can affect performance of your investment options over time. Rebalancing your investment options regularly—at least annually or as significant life events occur—may help keep them in line with your long-term goals.
- Keep tabs on any variable interest payments you have, such as credit cards or adjustable-rate mortgages. As rates move around, those payments may, too.
Are changing rates good or bad?
While lower rates feel better to most people—no one likes paying more than they have to—rate increases and decreases are neither good or bad. They’re more like an indication of the overall U.S. economy. The Fed raises rates when the economy is doing well to help prevent it from growing too fast and causing high inflation. The Fed lowers rates to help the economy continue growing.
Once you understand this, a rate hike doesn’t need to send your heart rate soaring. It’s generally a good idea to ignore the market chatter and keep your focus on fulfilling your long-term financial goals.
What to do next?
- Got a financial professional? They can help you figure out how interest rate changes could affect your financial and retirement goals. If you’d like to meet face to face, find one near you.
- Check our economic updates to keep track of how Fed decisions and other factors can affect the economy and your money.
Investing involves risk, including possible loss of principal.
Asset allocation and diversification does not ensure a profit or protect against a loss. Equity investment options involve greater risk, including heightened volatility, than fixed-income investment options. Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.
The commentary represents the opinions of Principal Global Investors. It should not be considered investment advice. No forecast based on the opinions expressed can be guaranteed and may be subject to change without notice. No investment strategy, such as diversification, can guarantee profit or protect against loss.
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