It’s been a few months since the Federal Reserve implemented its first rate hike in nearly 10 years. The move signaled that the economy has strengthened enough for borrowers to withstand higher interest rates. Still, many consumers are confused on how this will impact them personally.
How exactly will the rate change affect your life?
Rate Changes Have Big Impacts
The Fed funds rate has real effects on everyday consumers. Rate fluctuations can impact your mortgage payments, savings account interest rate, and inflation levels (which reduces your purchasing power).
In 2009, most U.S. financial institutions were experiencing a credit crisis, meaning that they were running out of capital to stay afloat. Because nearly every bank was experiencing this issue, the U.S. Federal Reserve dropped rates to nearly 0 percent to improve access to capital for both businesses and consumers. With the economy continuing to strengthen, rates are now increasing. By next year, Goldman Sachs sees them hitting 2.4 percent. Here are three ways you’ll be impacted in the coming years.
1. Higher Mortgage Rates
When the Federal Reserve makes it more expensive for banks to borrow by upping the Federal funds rate, banks pass on these higher costs to its customers. As rates have gradually fallen since the early 1980s, borrowers have been able to get cheaper and cheaper loans to buy houses. If you have an outstanding mortgage, now is the best time in decades to refinance your loan. Now that rates are rising, the cost of a mortgage loan has nowhere to go but up. If you take a look below, you’ll notice the Fed funds rate and mortgage rate tend to rise and fall in tandem. History suggests that mortgage costs could easily double if rates continue to rise.
2. Savings Rates
Back in 2006, many savings accounts were offering annual interest rates of 4 percent or more. Some banks paid as much as 6 percent annually. Today, the average savings account pays only 0.06 percent a year, almost completely eliminating a chunk of income for savers. Now that rates are moving higher, banks might start to pay you more to save money with them.
For now, the savings rate has remained stubbornly flat. But another rate hike or two could change the equation significantly. Over the coming years, savers will likely earn hundreds, if not thousands more per year in interest payments, especially if the Fed increases the rate a few more times.
Historically, low interest rates have reduced American’s incentive to save money. It makes sense that you’d probably save more if you get paid more in interest. As rates have slowly fallen in the past 30 years, Americans have started saving less (see below). Perhaps most telling is that drops in savings levels accelerated during times of rapidly falling Fed funds rates (eg. 2001-2004). When rates hold steady or rise, you actually see an increase in savings levels (eg. 1995-2000 or 2004-2007). With rates on the rise, you’ll not only get paid more in interest, but you and your fellow citizens will likely start to save more.
It’s not the most thrilling statistic, but inflation rates have a big influence on the price you pay for nearly everything. In the 1970s and early 1980s, inflation was consistently between 5 and 15 percent, meaning people needed to pay considerably more every year for the same goods.
When rates are low, it becomes easier for business and consumers to get credit to buy things, pushing up prices for these goods and services. To combat the issue of high inflation, the Federal Reserve set rates as high as 20 percent in hopes of restricting credit. Over the next few decades, inflation rates returned to fairly minimal levels.
Rising rates should continue to keep a lid on historically low inflation numbers. If you don’t think this is a big deal, just ask Canadians right now; fresh fruit and vegetable prices rose over 13 percent last year in Canada. Nearly six in 10 Canadians say it’s become more difficult in the past year to feed their families. If you’re American, you have little need to worry.
Cross-posted from Graphiq.