On a day-to-day basis, the numbers you worry about are likely the prices of the things you want to buy, the amount of money in your checking and savings accounts, your retirement stash (if it exists), and any outstanding debt balances you manage, plus their accompanying interest rates.
There's another number you may want to be aware of, and that's the federal funds rate — more commonly known as interest rates. Despite the flood of news headlines every time the Federal Reserve has a meeting, the majority of Americans aren't sure what the Fed does or what this number means.
Yet this number affects anyone with a bank account or looking to borrow money, because the Fed's decisions impact the cost of borrowing and the gains from saving. It's also a signal of how the economy is doing from the country's central bankers, which is relevant information for anyone looking to change jobs, buy property, or start a new business.
This week, the Fed will announce whether it will raise interest rates or keep them the same. Find out ahead what that means.
What Is The Fed?
The Federal Reserve — often called just the Fed — is a government institution created by Congress to direct monetary policy. It is managed by 12 individuals: seven governors and five Fed regional bank presidents. These are some of the top economists in the country.
The Fed's most visible work is regarding interest rates: By changing the supply of money in the U.S. banking system, the Fed is negotiating a juggling act between spurring the economy on by lowering rates, and slowing the economy down by raising rates.
Alongside this work, the Fed is also responsible for monitoring the financial sector. "Especially since the Dodd Frank legislation, they're sort of the frontline regulator, and are responsible for the supervision of banks and other financial actors to make sure we don’t have another financial crash," explains Josh Bivens, a research director at the Economic Policy Institute (EPI).
What Do Rising Interest Rates Mean For Me?
When the Fed wants to stimulate the economy, it tends to lower interest rates — which (eventually) lowers the cost of borrowing money, but makes saving less attractive. When they want to reign things in a little (to curtail inflation), they raise interest rates, which has the opposite effect. Although rates don't skyrocket overnight, the ripple effect that starts at banks gradually moves out to business owners and consumers, impacting them in inverse ways.
"Some of the big-ticket items that you tend to buy become a little more expensive, and so consumers end up spending less on them, which is one of the things that leads to higher interest rates reigning in economic growth," Bivens explains. "The other angle, besides consumers, is you have businesses that tend to take on debt to invest. Higher rates will discourage that, so you'll see a slowdown in business investment after a while."
How Might Rising Interest Rates Specifically Affect My Money?
Look at the kinds of debt you have — the most direct way that rising interest rates impact consumers is through any variable interest debt they hold.
In February, the Federal Reserve Bank of New York released a study showing that the amount of debt households held increased dramatically in the last half of 2016, "with a $32 billion increase in credit card balances, and $31 billion increase in student loan balances." One reason credit card debt has been on the rise is that many Americans haven't seen their paychecks increase significantly in the past few years — even as the economy has recovered after the Great Recession.
"When the Fed raises rates by a quarter of a percentage point — and that rate is the typical benchmark for most credit cards and home equity lines of credit — you can expect to see that quarter-point rate reflected on your credit card within one to two statement cycles, and within 60 days on your home equity line of credit," says Greg McBride, CFA, the chief financial analyst at Bankrate.com.
After the numbers are crunched, he estimates that could result in your credit card rate rising 1 percentage point from its rate two years ago. If you're a homeowner, the minimum payment on a $30,000 home equity line would be $25 more per month than it was before the Fed started hiking rates.
Those might sound like small increases in the general scheme of things, but people who lean heavily on credit card debt or maintain balances won't exactly cheer news about interest rates on those balances increasing their debt load. Neither will people who carry private student loans. While federal student loans are issued with fixed interest rates, many private student loans carry variable interest rates that would also fluctuate in tune with the Fed's decision.
How Can I Minimize The Impact On My Finances?
You might want to look into refinancing any variable rate debt you carry into fixed rates, especially if you have an adjustable rate mortgage, McBride says. Homeowners in particular might also want to consider locking in a fixed rate on the outstanding balance of their home equity line.
"Then, as far as that credit card debt is concerned, grab one of those zero-percent balance transfer offers," he suggests. "It gives you a window, some as long as 21 months, to get that debt paid off once and for all, and you're insulated from rising rates in the interim."
Are There Any Upsides To The Interest Rate Hike?
Your savings accounts might see a bit of a boost.
"Don't sit back and wait for your bank to raise your rates because most banks won't," McBride advises. "Instead, research smaller community banks, credit unions, and online banks, which offer more competitive returns on savings — as high as 1.3% on average — and a more regular pace of increases."
You won't get rich on 1.3% interest, he explains (especially since you won't even be keeping pace with the 2% inflation rate at that point), but you will be a lot closer to it — and earn tenfold the interest you're probably earning right now.
What's The Big-Picture Outlook?
Last month, the Fed voted to raise interest rates to a range between 1% and 1.25%. It was the FOMC's third interest hike in the last six months, and the fourth in 18 months.
From a national economic perspective, the move indicates a belief that the economy has recovered enough post-Great Recession to reign things in a little. After all, an overheated economy can lead to workers demanding big wage increases, eventually pushing market prices up and potentially leading to inflation. From an individual economic perspective, however, the only thing that's tightening may be your purse strings.
"The impact of a single quarter-point move is inconsequential, but the cumulative effect is mounting," says McBride, CFA. "That cumulative effect is starting to pressure some consumers, particularly those who have increased their debt loads and have very tight household budgets."