What an interest rate hike means for you

The Federal Reserve is almost definitely going to raise interest rates this year, likely in September.

That might not sound very interesting or important, but it is. It’s incredibly important and it will have a sizeable impact on your money. In the most basic terms, a Federal rate hike will be great if you’re saving money and not so great if you need to borrow money.

The very, very basics of the federal funds rate

To understand the potential impact of a rate hike, first you need to know a little bit about the federal funds rate. Financial institutions are constantly lending money back and forth. In every transaction a new interest rate is negotiated. The federal funds effective rate is the weighted average of all of these interest rates.

The Federal Reserve, meanwhile, looks at the overall economic landscape and decides what they believe would be the ideal interest rate for our current, national economy. This is called the federal funds target rate. The Federal Reserve then uses something called open market operations – usually the buying and selling of government bonds – to manipulate the flow and availability of money until the effective interest rate aligns with the target interest rate.

So when we say there will be a rate hike that means that the Fed is going to take certain actions to drive up the effective rate until it hits their predetermined target.

The effect of interest

When the economy plummeted in 2008, the Fed dropped interest rates way down in the hopes that it would induce growth. After all, lower interest rates mean less costly loans. The thought was that lower rates would make it easier for consumers to get back to spending and investing. It worked, too (more or less). The economy has been steadily rebounding ever since.

Now the Fed is ready to finally start raising rates again.

That’s good news if you already have money. Since 2008, money held in savings accounts hasn’t really earned much in the way of returns. That should change. Interest rates on savings accounts and other long-term investment vehicles will very likely increase.

If you need to borrow money, however, the hike might hurt. Rates for mortgages, auto loans, and credit cards will also increase, making new loans more expensive and existing lines of credit more costly.

How to prepare

As of now, the rate hike hasn’t taken effect, and may still get pushed back. 2015 was a big year for mortgage refinances, driven in large part by the looming threat of increased rates. If you’ve been considering a refinance, now may be the best time to act, as rates may be climbing soon.

If you have substantial credit card debt, you may want to consider taking active steps to reduce that debt load. American credit card debt is on the rise once more, up over 3 percent from last year. The average household credit balance is nearly $16,000.

Increased interest rates mean increased interest payments on outstanding debts. So if you’re struggling to manage your unsecured debt already, things aren’t going to get any easier. Now is really the best time to consider your options and create a plan to reduce your debt load. That might mean utilizing consolidation loans, balance transfers, or a Debt Management Plan as part of your effort to burn debt quickly.

If you’re carrying a high level of debt and would like help understanding your options ahead of a potential rate hike, consider speaking with a certified budget counselor. On the other hand, if you’ve got money saved up and aren’t sure where to put it, be sure to speak with a qualified financial advisor. As interest rates go up it becomes just that much more important to make smart decisions with your money.

Jesse Campbell photo.

Jesse Campbell is the Content Manager at MMI, with over ten years of experience creating valuable educational materials that help families through everyday and extraordinary financial challenges.

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