The Federal Reserve did not raise the benchmark federal funds rate at its meeting this week, keeping the rate at a target range of 5.25% to 5.50%. This is the highest the federal funds rate has been since 2001.
Why does the Fed raise interest rates?
When the Fed raises interest rates — which makes it more expensive for consumers and businesses to borrow money — its goal is to decrease demand and restore price stability.
At the start of the COVID-19 pandemic, the Fed slashed rates to zero as part of a broader fiscal and monetary stimulus strategy to prevent long-term economic damage. The plan worked, as the U.S. avoided the worst-case scenario. The job market quickly recovered, households were able to save money and an effective vaccine helped bring life back to normal.
However, an imbalance between low supply and high demand has created upward pressure on prices across the economy. The pandemic, as well as Russia’s invasion of Ukraine, has impacted shipping, labor, energy and commodities markets. Meanwhile, there’s been more competition among consumers to purchase goods and services and more competition among businesses to hire and retain workers.
Together, those dynamics have caused prices to rise significantly, according to Consumer Price Index (CPI) data. Higher interest rates will decrease demand and hopefully cause prices to fall, but a probable recession looms over the horizon.
What to do if interest rates rise
Although a Fed rate hike isn’t happening this month, another one could come in the future. When a Fed rate hike happens, what does it mean for you?
“Expect to pay more on the interest charges from your credit card company, and auto loans and mortgages will also become more expensive,” says Ken Tumin, LendingTree’s senior banking industry analyst. “On the flip side, we can generally expect banks to raise their savings account rates when the Fed increases its benchmark rate.”
Here’s how to prepare for rising interest rates.
Pay down your credit cards
Your credit card interest rate is likely to go up within a month or two of rates going up. If you’re carrying credit card debt, this means your monthly payments will grow and you’ll be paying more in interest — costing you a lot more money.
If you currently have credit card debt, consider making bigger and more frequent payments to pay it off more aggressively. Signing up for a 0% interest balance transfer credit card or getting a debt consolidation loan could be another option to protect you from paying more interest, at least in the short-term. Looking to open a new card altogether? A card with an intro 0% annual percentage rate (APR) offer can shield you from fluctuating interest rates for a while.
Lock in your mortgage rate
If you already have a fixed-rate mortgage, don’t worry — your interest rate will stay the same.
Costs for aspiring homeowners may increase after a rate increase, though. “Mortgage rates could trend up,” says Jacob Channel, senior economic analyst for LendingTree, but “there’s no guarantee that mortgage rates will change all that drastically. Remember that while the Fed’s actions do impact mortgage rates, it doesn’t directly set them. With that said, rates on products like home equity lines of credit (HELOCs) and adjustable-rate mortgages (ARMs), which are pegged to the prime rate, will increase” if rates do.
If you’re looking to buy a home or refinance a mortgage, don’t stress about rates. “While mortgage rates are important, obsessing over them too much is liable to do more harm than good,” Jacob says. “If you’re in a place right now where you can afford to buy a home without becoming excessively cost burdened, then you shouldn’t worry too much about whether or not rates could eventually come down.”
Set your auto loan rate
Like mortgage rates, auto loan rates can go up with Fed rate hikes while lenders adjust to the new federal funds rate. Refinancing terms also become less favorable in an environment of rising rates. If you think rates will go up, locking in a lower rate now may help ensure you’re spending less money on interest and getting the best value on your car purchase.
If you’re planning on buying a new or used car, pay attention to the APR and move fast if you want today’s rates. If the federal funds rate continues to rise, the interest rates on new auto loans could rise as well.
Grow your savings
There’s some good news when it comes to the Fed raising interest rates: savings and other deposits earn more interest. “Deposit rates are reaching highs not seen in more than a decade,” says Ken.
But be sure to shop around for the best rates, because not all banks will pay you more. “Many banks have been slow with rate increases as their deposit levels have remained high,” says Ken. “To benefit from the higher interest rates, you may have to move your money to those banks which are willing to pay higher savings account rates.”
Look for a high-yield savings account —online banks will probably be your best bet — to ensure you’re getting a competitive rate. You may also find a certificate of deposit (CD) or an I bond to be a good option when it comes to protecting the value of your long-term savings. They have higher rates, but you’ll need to sacrifice some short-term liquidity.
Prepare for student loan repayment
Federal student loan repayments began in October.
Rising interest rates won’t impact existing federal loans, which have fixed interest rates, but could make future student loans more expensive. If you have fixed-rate private loans, those rates won’t change either, but the rate on variable-rate loans will very likely rise. Student loan refinancing may become less common as interest rates rise, but the terms for private, refinanced loans could become less favorable moving forward due to rising rates.
What’s next for the Fed and the economy
The path of future Fed rate hikes depends on whether progress has been made in bringing inflation down. The Fed considers a wide range of economic data points, including CPI and Personal Consumption Expenditure (PCE) inflation, as well as more specific price data.
Chairman Jerome Powell has acknowledged that higher rates will cause an increase in unemployment. It’s likely that millions of Americans will lose their jobs during this tightening cycle as the demand for workers decreases and a strong labor market weakens. Powell has argued that labor market strength cannot exist in the long run without price stability, so the Fed is willing to tolerate that pain in its effort to slow down inflation.
Frequently asked questions
How does raising interest rates help inflation?
The Fed raises interest rates to slow the amount of money circulating through the economy and drive down aggregate demand. With higher interest rates, there will be lower demand for goods and services, and the prices for those goods and services should fall.
Did the Fed raise interest rates?
No, the Fed did not raise the federal funds rate at its last meeting in May. While the Fed doesn’t directly control the rates at which banks lend to consumers and businesses, the federal funds rate, which determines the rate at which depository institutions lend each other money, affects those rates.
When is the next Fed rate hike?
The Fed could raise interest rates again at its next meeting, which is scheduled for June 11-12.
