How will raising interest rates affect me?
Many people are unaware of how the Federal Reserve’s recent decision to raise interest rates will affect their lives. Interest rates are a foreign concept to many individuals. Some people have never been taught how interest rates work, while others have not experienced a rise in interest rates in nearly a decade.
The last time the Federal Reserve announced it would raise interest rates was June 2006. This is a full year before the release of the very first iPhone. That’s right, the last time the Fed raised interest rates was before the Apple iPhone even existed.
What are Interest Rates?
Interest rates determine the cost of borrowing money from one bank to another. The Federal Reserve is granted the power to determine interest rates. The Federal Reserve’s decision to lower, raise, or keep interest rates the same has a large impact on the economy.
Lowering Interest Rates
During periods of time when the economy is slowing the Fed may choose to lower interest rates. A slowing economy is characterized by rising unemployment, less profitable companies, and a decrease in consumer spending. The Fed lowers interest rates when the economy is performing poorly in order to decrease the cost of borrowing money. Lowering interest rates enables companies and consumers to afford goods and services.
Keeping Interest Rates the Same
During periods of time where the economy is neither growing nor slowing at a rapid pace the Fed may choose to maintain interest rates. Interest rates are a tool to prevent significant economic events that may negatively affect companies and consumers. During periods where the economy is not changing too fast the Fed may choose to keep interest rates the same.
Raising Interest Rates
During periods of time when the economy is expanding the Fed may choose to raise interest rates. The economy tends to grow when employment rates are high, companies are prosperous, and consumers are spending. The Fed raises interest rates when the economy is rapidly growing in order to prevent inflation.
How Does Raising Interest Rates Affect Me?
Higher interest rates allow banks to pay higher interest on deposited money. However, this also entails that the cost of borrowing money will be higher.
When the Fed decides to raise interest rates this is usually a good sign that the economy is performing well. A growing economy can have great effects on employment, companies, and consumers. People tend to enjoy higher interest rates on their savings accounts when the interest rates are raised. This may also have a positive effect on particular investments. Bond yields are typically pushed up during these periods.
However, when the interest rates rise there are some negative effects, especially in concerns to borrowing. Some negative effects of raising interest rates includes: an increase in credit card interest rates, rise in variable home equity lines, and higher interest rates on car loans.
Preparing a Raise in Interest Rates
It is important to keep up to date on interest rates especially in regards to saving, spending, borrowing, and investing. A well balanced portfolio can often protect you from changes in interest rates. When developing a financial plan you should discuss with your financial advisor how interest rates will affect your financial goals. The right financial advisor will keep you up to date with current economic trends and make changes accordingly.
Right Financial Advisor’s Nick Bredow, contributed this report.