Why You Should Care About Interest Rates

Interest rates can significantly impact everything from your house payments to your investments.

Eight times a year, 12 members of the Federal Open Market Committee vote on whether the Federal Reserve should raise or lower interest rates. “People should be paying attention,” says Deeksha Gupta, a finance professor at Pittsburgh’s Tepper School of Business.

Many people don’t realize that interest rates can affect everything from the cost of a mortgage, to the interest earned in a savings account, to stock market returns. Once you understand interest rates, the more you can maximize your finances.

The Impact of Interest Rates

The decision to lower or raise what’s called the overnight rate – a short-term lending rate that impacts many other kinds of interest rates – can be a complicated one. “If the economy is struggling, the Federal Reserve will decrease rates to reduce borrowing costs and stimulate the economy. If the economy is doing well, it will increase rates to prevent inflation,”says Gupta. These movements could directly affect you and any debt you may have.

Examples of what can be impacted
  • If interest rates today rise, interest on new loans or loans that are not fixed, such as a line of credit or an adjustable rate mortgage, will increase, too. That may prevent you from reaching some financial goals, since you’ll now owe more money.
  • If rates and borrowing costs drop, you may be able to lock in a cheaper interest rate for mortgages or pay less interest on certain credit. This would allow you to put more money toward retirement.
  • Interest earned in a savings account can fluctuate with the overnight rate. If rates rise, the interest you earn on money held inside of a savings account can also increase and vice versa.

There are other impacts, too – housing prices tend to inflate when rates stay low for the long term, wage growth can be affected, and long-term bond yields can change, which might impact fixed-income portfolios and more.

How to manage interest rate changes
Pay down debt before rates rise

One easy thing to do, whether rates are high or low, is reduce debt, especially adjustable mortgage rate debt. When rates are low, more of your payment will go toward the principal than interest. When rates rise, your now higher interest rate will be calculated on a lower loan amount. You can figure out how a change might affect you by using an interest rate calculator.

Reduce spending and save more

When you think rates are going to rise, that’s the time to cut back on spending and put even more into a savings account. Not only will you lessen the potential for accumulating debt, you’ll have more money in your account when savings rates increase.

Wait to buy a home

If you think rates will fall, waiting to lock in a lower rate could save you thousands of dollars over the lifetime of your mortgage. It may also be possible to renegotiate an existing mortgage at a lower rate. On the flip side, if you think rates will rise, consider buying a house before they do.

Negotiate inflation-adjusted raises

If inflation rises faster than your income, you’ll end up losing money because you’ll have to pay more for everyday items. “Since lower interest rates have the potential to increase inflation, if you think rates might fall, ask to put inflation-adjusted raises in your employment contract,” suggests Gupta.

It’s clear that interest rate movements can have a big impact on your finances. That’s why Gupta’s advice – to pay attention – is notable. “Some things, like your debt, could be felt almost immediately,” she says.

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