When the Federal Reserve raises interest rates, it affects your finances and investments in a variety of ways. Understanding how this happens can help you prepare for it.
The Fed can control inflation and stabilize the economy by raising and lowering its target federal funds rate, which controls how much it charges banks to borrow money. By increasing or reducing this rate, the Fed impacts credit cards, mortgages, auto loans and savings/money market accounts. For consumers, the most obvious effect is higher interest rates on consumer debt. However, the increase in rates also makes saving more appealing and encourages those with debt to pay off their loans and credit card balances.
Similarly, the Fed lowers its interest rate when it wants to boost the economy and consumer spending. By lowering the cost of borrowing, the Fed hopes to encourage businesses to expand and hire employees, thus spurring consumer spending.
However, if the Fed starts to raise its interest rates too rapidly, it could slow economic growth and consumer spending by making it more expensive to borrow. For example, families might be less willing to purchase homes at 6% mortgage rates than they are at 3.5%, and companies may delay their expansion plans. A rising interest rate isn’t good news for bond investors, either, as it tends to decrease the price of existing bonds. It’s important to work with a financial advisor when positioning your savings and investments in the face of an interest rate hike or cut.