The Federal Reserve announced last month another 0.25% interest rate hike. Part of the ongoing efforts to combat inflation, this quarter percentage point increase brings the fed funds rate to their highest level in more than 22 years.
When the Fed raises interest rates, they increase what’s known as the federal funds rate. Although this is not the same rate consumers pay, the federal funds rate still affects us regular consumers in our everyday lives. As we’ve previously explained, higher interest rates raise costs for borrowers. At the same time, they can also mean higher yields for savers. Here’s what to know about the implications of a Fed rate increase on your savings, and how you should navigate these changes.
What a Fed rate increase means for your savings
When the Fed raises the federal funds rate, it influences the interest rates that banks charge for borrowing money. This, in turn, affects the interest rates the banks offer on various financial products, including savings accounts.
Improved earnings
With a Fed rate increase, banks tend to raise the interest rates they offer on savings accounts. As banks increase their savings account rates, your account will accumulate interest at a faster pace. This means that your savings could potentially earn more interest over time.
Keep in mind that the impact on savings rates might not be immediate or even all that significant, and you may owe taxes on any interest income you earn. Still, it’s better than your interest taking a dig in the opposite direction.
More incentive to save
Higher interest rates can incentivize individuals to save more money. This is because the potential to earn greater interest can make saving more attractive compared to spending or investing in riskier assets.
Borrowing money is more expensive
On the flip side, higher interest rates can make borrowing more expensive. This might affect loans and credit card balances, potentially leading to reduced borrowing and decreased spending. This is part of the Fed’s strategy to manage inflation and slow economic growth without triggering a recession.
What to do when the Fed rate increases
A Fed rate increase might impact your savings strategy, so make sure your goals are aligned with the new interest rate environment.
Shop around for the best rates
A Fed rate increase doesn’t instantly change the rates your bank offers, but it can lead to an increase if banks start raising rates on savings accounts to attract new customers. Research and compare rates from different financial institutions to find the best option for your needs. For instance, online banks and credit unions may offer the most competitive rates.
Evaluate your options
If you’re looking for higher returns than what a savings account can provide, explore investment options such as certificates of deposit (CDs), money market accounts, or low-risk investments. Keep in mind that these options may come with different levels of risk and liquidity.
Reassess your debt management
If you have outstanding debts, especially high-interest debts like credit cards, a rate increase might make repayment more challenging. Rising interest rates can lead to a higher average interest rate on your account, and even bigger payments down the line. Consider reevaluating your debt management strategy to minimize the impact of higher borrowing costs by paying off the highest interest accounts earlier.
The bottom line
Higher interest rates raise costs for borrowers, but they can also mean higher yields for savers. While the Fed is raising interest rates right now in an attempt to continue to ease inflation, it’s important to be a conscientious borrower and saver. This might mean holding off on taking out a loan to pay for a large purchase for the time being, as well as boosting your power as a borrower by working to increase your credit score; while at the same time stocking more money away in a high-yield savings account.