The Federal Reserve has raised the benchmark interest rate four times in 2022, including increases of 0.75% in June and July, and interest rates are likely to rise again.
When the interest rate changes, there are real effects on how businesses and consumers shop. To understand how interest rates affect your personal finances, you need to understand exactly how they work.
What is an interest rate?
A interest rate is the price you pay to borrow money. Common examples include a mortgage, car or student loan, or credit card. When a lender lends money, they profit from the interest paid. Ultimately, these rates will affect the overall price you’ll pay once the loan is paid off. Because no two loans are the same, it can be difficult to decide which type of loan is right for you. Before you borrow, make sure you understand how the interest rate will affect your final repayment amount.
Why is the Federal Reserve raising interest rates?
Interest rates are considered to be those of the Federal Reserve main tool to fight inflation. The Fed can speed up or slow down the economy by moving interest rates down or up. When inflation is too high, the Federal Reserve will typically raise interest rates to help slow the economy and lower inflation. When inflation gets too low, the Federal Reserve lowers interest rates to stimulate the economy and help push up inflation. By raising interest rates and, therefore, making purchases more expensive, the Federal Reserve hopes to dampen Americans’ willingness to spend money to fight rising inflation.
How interest rates can affect you
Regardless of your age, whether you are buying your first home or nearing retirement, rising interest rates can affect you.
While the prime interest rate isn’t directly tied to your mortgage rate, those looking to buy a home right now are hurting the most. Mortgage rates have increased with inflation all spring and summer. Let’s take a loan of $400,000 as an example of this increase. A few months ago, the payment on this loan would have been around $1,700 per month. Today, however, the payout has increased to almost $800. With this dramatic increase and rising house prices, mortgage applications are down nearly 15% from this time last year.
If you’re thinking of buying a house or a car and want to save some money, try to lock in a long-term loan rate as soon as possible before it goes up even more.
If you’re past the days of buying new homes and are planning retirement, interest rates could also affect you. Interest rates have no direct influence on the stock market, but they can cause it to fluctuate. Rising rates have a significant effect on bond portfolios. When interest rates rise, bond prices fall. Any long-term bonds you have may feel this impact significantly, while short-term bonds may be less affected. In the meantime, if you’re considering an annuity, rising interest rates could benefit you.
Having a diversified portfolio that includes stocks, bonds and cash equivalents is your best tool for maintaining growth through rising interest rates. Of course, before making any major investment decisions, meet with a financial advisor to discuss your options.
Whether interest rates are rising or falling, working with a financial advisor is always a good idea. From building your retirement savings to planning your financial future, they’re the experts. Don’t be afraid to ask questions. It’s your money, and they want to do what’s best for you!
Founder and CEO, Drake and Associates
Tony Drake is a CERTIFIED FINANCIAL PLANNER™ and the founder and CEO of Drake and associates in Waukesha, Wis. Tony is an Investment Advisor Representative and has been helping clients prepare for retirement for over a decade. He hosts the weekly radio show The Retirement Ready on WTMJ Radio and is regularly featured on Milwaukee television stations. Tony is passionate about building strong relationships with his clients to help them develop a solid plan for their retirement.