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The Good, the Bad and the Ugly of Interest Rates Hikes

May 17, 2022

The primary tool the Federal Reserve (the Fed) uses to conduct monetary policy is the federal funds rate. Changes in this rate influence other interest rates as well as broader financial and economic conditions.1 When inflation is too high, the Fed typically raises rates to slow the economy and help push inflation down. We saw that in March when the Fed approved a 0.25% rate hike— the first increase since December 2018—and again in May with a 0.50% increase. As inflation surges at the highest levels seen in more than 40 years,2 many economists expect rate increase to total 3%-3.25% by year-end.3 That makes it likely that rising interest rates will impact your wallet in the coming months. Whether that’s good, bad, or ugly depends on a number of factors.

The good
You may begin to see higher returns on short-term savings, such as bank savings accounts, certificates of deposit, or certain fixed-income investments. That reduces the need to take on added risk by investing money earmarked for short-term expenses in assets that fluctuate in value over time.

The bad
As interest rates rise, the cost of borrowing becomes more expensive as we saw earlier this year when 30-year mortgage rates soared past 5% for the first time in more than a decade.4 Homeowners who took the opportunity to lock in lower fixed rates on home loans in recent years will see no impact from rising mortgage rates. However, those with variable-rate mortgages or home equity loans should expect an increase in their interest payments going forward. As financing costs increase, homeownership becomes less affordable for buyers. While housing prices typically decline to attract more buyers when mortgage rates rise, it’s unclear if that trend will hold in today’s hot housing market where demand exceeds supply.

The ugly
When borrowing money, you want the lowest rate possible, especially when financing assets that will depreciate over time, such as a car, boat, furniture, or appliances. Even a slight increase could translate to hundreds of dollars more in interest over the life of the loan. Revolving credit card debt is another area where rising rates can get ugly. The higher the annual percentage rate (APR), the longer it can take to pay off credit card debt. While you can’t directly control the rates that lenders charge, you can take steps to ensure you get the best rate available, based on your credit history. Lenders consider your credit score when evaluating borrower risk. Ideally, you want yours to remain in the “very good” to “excellent” range.

To learn more about managing credit, visit myfico.com. If you have concerns about the impact of rising interest rates and inflation on your income in retirement, let’s schedule a time to talk.

1 http://www.frbsf.org/education/teacher-resources/what-is-the-fed/monetary-policy/

2 http://tradingeconomics.com/united-states/inflation-cpi

3 http://www.reuters.com/business/big-fed-rate-hikes-ahead-amid-early-signs-hotinflation-is-peaking-2022-04-29/ 4 http://www.freddiemac.com/pmms

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