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How will higher interest rates affect you?

September 23, 2022 | 5 min. read

With the Federal Reserve intent on raising interest rates to get inflation under control, it’s a good time to assess your finances and determine how your borrowing and savings habits will be affected.

We have all felt the effects of the highest inflation rates since the early 1980s this year, as the prices of everything from gas to groceries to travel have soared. The hope that this was a short-term phenomenon that would work itself out has slowly given way to the realization that it represents a more sustained threat to our economy. As a result, the Federal Reserve, our nation’s central banking system, is aggressively intervening in an effort to control inflation. After enacting 25 basis point (0.25%) increases in the federal funds rate in March and May, the Fed ramped up its efforts with back-to-back 75 basis point (0.75%) hikes in June and July, the biggest back-to back hikes since the 1980s.   

Why is the Fed raising interest rates? Higher prices occur when demand exceeds supply. Think of what happens to the price of tickets on the resale market when a big concert or sporting event comes to town. By raising rates and making borrowing more expensive, the Fed hopes to reduce consumer and business demand and bring them back in line with the supply of goods and services. When that happens, inflation will subside.    

Unfortunately, this hoped-for cure for inflation presents its own set of challenges…

The cost of borrowing increases

If you are currently locked in to a low fixed-rate mortgage, you don’t need to be concerned about your home loan. However, if you’re shopping for a new home, or if you have an adjustable rate mortgage on your current home, you should expect higher monthly payments. In addition, home equity lines of credit are susceptible to changing interest rates, so if you have a balance on yours, you may want to reach out to your borrower to determine if you will be affected.

According to research by credit reporting service Experian, the average American credit card balance is $5,221. Since most credit cards have a variable rate, if you have a balance on your card that you are paying off monthly, the finance charges you pay are at risk of ratcheting up. Unless you increase your payments, that means you’ll be paying less toward your principal every month and it will take you longer to pay off your balance.

It’s a good time to review your student loans too. Federal student loans are tied to a fixed rate, so those payments should remain unchanged. But if you have additional private loans, double-check the rates and repayment terms to make sure you understand how you will be impacted.

Stock and bond prices can be negatively impacted

The stock prices of fast-growing companies can be negatively impacted by rising interest rates because they make it more expensive to borrow the money needed to invest in innovation and expansion. And to compound that effect, a slowdown in spending by customers who suddenly have less disposable income can reduce revenues.

Almost as important is the impact Fed rate increases – or even anticipated Fed rate increases – tend to have on market psychology. Investors often assume that an increase in rates will have a negative impact on stock prices well before any evidence of that outcome is apparent! Justified or not, this can lead to a short-term sell-off in the market. The key is not to over-react or be tempted to deviate from your long-term plan.

Bond prices aren’t immune to a rising rate environment, either. When the Fed increases rates, the market prices of existing bonds immediately decline – because new bonds offering investors higher yields will soon be coming on to the market.

Jobs and wages can be affected

A sustained period of high interest rates that chokes demand and hampers businesses could reduce hiring, or even lead to layoffs and lower wages. But it’s premature to proclaim or even anticipate a full-blown or sustained recession. The Fed’s objective in aggressively raising rates in June and July is to try to quickly get inflation under control so that they can entertain the possibility of beginning to lower rates next year or in 2024.

Savers benefit from higher rates

If there’s a silver lining to a higher-rate environment, it’s that the interest rates paid on savings accounts, money market accounts and certificates of deposit will rise. Don’t get too excited, though. As you’ve probably already noticed, though, these rates don’t increase nearly as quickly or as substantially as the rates on loans!

What does all of this mean for you?

When interest rates change, it’s a good idea to assess your finances and determine how your borrowing and savings habits will be affected by the economic climate. If your loans are vulnerable to rising rates or you’d like to learn about optimal savings and investment strategies, contact your Financial Advisor to map out a plan.

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