There has been a lot of interest lately in interest rates. For good reason. After years of being somewhat forgotten, interest rates have made a comeback. If interest rates were an actor, they would be Brendan Fraser.
OK, that’s not quite true. People seem to like Brendan Fraser a lot. Most people aren’t fans of higher interest rates.
As you’ve probably heard, the Federal Reserve just raised interest rates again, a quarter point, despite a lot of talk that maybe this time it wouldn’t due to the recent Silicon Valley Bank debacle. So what do rising interest rates mean for you?
“Nothing good,” said Stephen Henn, an adjunct professor of economics at Sacred Heart University in Fairfield, Connecticut. “When the Fed raises interest rates to combat inflation, they are trying to slow consumer spending and cool the economy. That impacts everyone.”
He has a point. Let’s look at some of the ways the recent interest rate hikes could end up affecting your life.
1. Rising interest rates will affect your savings account.
We’ll start here because this is where everyone actually loves to see higher interest rates. People seem to rank high interest rates on savings accounts almost as high as they rank puppies and ice cream cones.
“Depending on the institution, savers can find interest rates between 3.0% and 4.5% on their short-term savings or CDs, which is a significant increase compared to the low rates of the past few years,” said Eric McAlley, who spent 24 years working in investment management and is now an assistant teaching professor of finance at Quinnipiac University in Hamden, Connecticut.
Of course, if you’re thinking, “Wait, my bank is still offering up something less than 1%,” McAlley says that that’s because many banks — the largest ones — don’t have a lot of incentive to offer generous interest rates.
“These larger banks with large investment banking operations have excess deposits in their bank from government operations and the increased savings rate during the pandemic,” McAlley said.
In other words, the biggest banks will do just fine with or without your savings. But many smaller banks, online banks and credit unions want to stay competitive with the traditional brick-and-mortar banks, so they tend to offer more generous interest rates.
2. Rising interest rates will affect your investments.
Rising interest rates will help your savings account, but maybe not all the places you invest your money.
“People who own stocks or bonds may see the value of those assets decline. As their wealth falls, they may reduce their spending on goods and services,” said Dave Gulley, a professor of economics at Bentley University in Waltham, Massachusetts. “On the upside, savers who invest in CDs or Treasury securities are seeing far higher payments. New buyers of bonds will see higher yields due to the fall in bond prices. So, there are opportunities to take advantage of higher rates.”
Unfortunately, because inflation has been high, you may feel like you don’t exactly have any extra money lying around to plop into a high-yield savings account or a CD, also known as a certificate of deposit.
Interest rates and their effect on savings accounts and investments, in fact, often create wage inequality, according to Ahmed Rahman, associate professor of economics at Lehigh University in Bethlehem, Pennsylvania.
“Generally, interest rate increases will help savers who tend to be older and richer, and hurt borrowers who tend to be younger and poorer,” Rahman said.
3. Your home situation could be affected.
If you own a house and you have a fixed interest rate, and you aren’t selling or buying a home any time in the foreseeable future, you should have zero stress in this part of your life. If you’re a renter and have no plans to buy a home any time soon, you, too, probably have little to worry about.
Everyone else may not be so fortunate.
“Anyone who bought a home in recent years using an adjustable-rate mortgage will be facing a rude awakening and potentially much higher home payments the next time the interest rate on their mortgage resets,” said Stephen Craft, dean of the Hammock School of Business at Oglethorpe University in Brookhaven, Georgia.
“Generally, interest rate increases will help savers who tend to be older and richer, and hurt borrowers who tend to be younger and poorer.”
Renters also may be a little hesitant about ditching their rental. As McAlley explained, “Higher interest rates can significantly increase the cost of borrowing.” So buying a home right now might be a little unpalatable, and if your credit isn’t that great, you may find that it’s even harder to become a homeowner.
That’s because lenders are being more selective when lending money, according to Rahman.
“Greater scrutiny by lenders may mean that those with lower credit ratings can get squeezed out of loan markets,” Rahman said.
On the other hand, Rahman said, as homes become more expensive, “this will lead to slower sales and price drops in some areas.” So for some homeowners, especially those with good credit, you may find that it’s going to be easier to buy a house.
And Henn pointed out that while mortgage rates are climbing, home prices have been going down, so a new homeowner may find that their monthly payment won’t be all that much higher than it otherwise would.
4. Rising interest rates may make your next car more expensive.
According to Kelley Blue Book, the average price of a new car is $48,763 — and we apologize that this article doesn’t come equipped with smelling salts.
For a few years, new and used cars have been difficult to purchase, depending on what city you live in and the model you’re looking for. Many factors have been blamed, from the pandemic to supply chain issues to microchip shortages and low inventory. Higher interest rates will likely drive up the price of cars even further, experts say.
Still, if you’re in the market for a new or used car, it isn’t that you won’t be able to find one. You just may not find it at a price to your liking, and it may not be the make and model or color you were hoping for. Ah, that new car smell of lowered expectations.
5. Interest rates affect any loan you want to take out.
You’ve got things to do, so we won’t mention every type of loan that will be affected by rising interest rates. Suffice it to say that any loan you want to take out will now be more expensive.
Max Jaffe is a certified public accountant and treasurer for TBS Retirement Planning in Hurst, Texas. He has a sobering and interesting way of looking at how devastating climbing interest rates can be to the debt that you have.
“Let’s say your credit card is now charging 18% interest,” Jaffe says. “That means without making any other purchases – and no payments – your credit card balance will double in as little as four years. If that rate increases to 24%, then it’s only three years. Albert Einstein said, ‘Compounding interest is the most powerful force in the universe.’”
(We checked. The quote is often attributed to Einstein, though may be an urban legend. And as for whether compound interest is actually the most powerful force in the universe, if there are any universe-dominating villains who would quibble with that statement, we may have to agree to disagree.)
Of course, you wouldn’t go three years without making credit card payments — and if you did, the credit card company would probably shut down the account as your credit score plummeted, do what’s called a charge-off and likely stop charging interest. So it’s fortunately not a realistic analogy, but Jaffe says that it nonetheless shows what increasing interest rates and compound interest can do to debt.
6. Rising interest rates can affect your job.
Now, don’t worry. Your job may be perfectly safe. Interest rates may not affect your specific position whatsoever, and given the labor shortages, a lot of employers seem reluctant to shed employees. But then again, your job could be affected.
“People who work in industries or occupations that are sensitive to rate changes should be concerned,” Gulley says. “For example, sales of homes have generally declined in the face of higher rates. Mortgage lenders and real estate agents are seeing lower demand for their services.”
7. Higher rates will definitely impact the economy at large, though we don’t yet know how.
When interest rates go up, the economy in general is affected. That, nobody disputes. But will the economy somehow improve, or get worse? And if worse, a little worse or a lot worse? That’s what everybody is wondering.
The whole point of the Federal Reserve raising interest rates is to keep inflation in check. Inflation has had the energy and enthusiasm of an out-of-control drinker on a bender lately. (Perhaps you’ve noticed.) If the Fed can make borrowing money more expensive, maybe people will save more money for a rainy day instead of immediately putting it into the economy. If that happened, prices would go up less fast. Inflation would be tamed.
That’s the thinking, anyway, and with any luck, the Fed will pull off this setting-high-interest-rates experiment without crash-landing the economy. Jaffe offered up an example of what often happens when interest rates go up.
“With higher interest rates, companies reduce their borrowings,” Jaffe said. “This means new equipment they were going to purchase for their employees will not occur in the near term, and if purchased at all, will be in the future.”
Jaffe said that maybe this hypothetical company was going to build a new factory and would have needed more employees, and maybe already hired some.
“Since that plant will not be built in the near future, they now have to lay off those new employees. Since those employees no longer have a paycheck, they spend less, which causes a ripple effect in the economy, and eventually, we have a recession,” Jaffe said.
Financial experts must be a lot of fun at parties. But remember, it was just a hypothetical.