Money Smarts Blog

On June 15, 2022, the Federal Reserve raised interest rates by 0.75% - the biggest increase since 1994. This was the third and most aggressive rate increase in 2022. This probably isn’t news to you, but do you truly know what it means and how it could affect you?

Let’s start with who the “Fed” is.

Not too hot, not too cold. Just right. That’s the economic mission of the United States Federal Reserve, also called the central Bank of the U.S. … and the Fed. According to FederalReserve.gov, the Fed is responsible for five general (but very important) functions:

• Conducts our nation’s monetary policy by controlling the supply of money in our economy
• Promotes the stability of our financial system and seeks to minimize systemic risk
• Promotes the safety and soundness of individual financial institutions
• Fosters payment and settlement system safety and efficiency
• Promotes consumer protection and community development
  

Okay, so what’s this have to do with interest rates?

Let’s hone in on the Fed’s first responsibility listed – controlling the supply of money in our economy. There are a multitude of tools the Fed uses to control the supply of money, but the most prominent and effective tool is their ability to influence interest rates.

But wait … why is it important to control the supply of money in our economy? Simply put, to ensure our economy remains healthy, the Fed must regulate the amount of money in circulation.

Currently, we have too much money in circulation. How do we know? Because of our current inflation issue ... if you want to read up on that, I wrote an article about it in the Spring edition of Pathfinder Magazine. When consumer demand is high, prices go up – it’s the basic laws of supply and demand.

How exactly do higher interest rates help the economy?

When the Fed raises interest rates, they’re increasing the cost of credit throughout the economy. With more expensive credit or higher interest rates, loans become more expensive for consumers and businesses. Seems like a bad thing, right? It makes it more difficult for consumers and businesses to get loans for the things they need, including growth. Well that’s precisely the goal. Because loans are more expensive, families may put off buying a new home and a business may reconsider expansion.

Higher interest rates = higher borrowing costs = fewer loans being taken out / consumers and businesses eventually start spending less (less money circulating) = demand for goods and services then drop, which causes inflation to fall.

That makes sense, but how does this affect me?

Well, there’s quite a few ways this can affect you. Take a look.

Before we get into this, it’s very important to understand that your financial health plan is specific to you and not a one-size-fits-all. One plan or recommendation does not suit all for this subject matter. As always, if you have any questions or want to sit down with a Financial Health Coach to see what your options are and what’s best for YOU, give us a call at 309-793-6200 or schedule an appointment online.

• Variable loan costs rise: Borrowers with variable or adjustable-rate loans will see their payment amounts rise as the interest rates rise. If this is you, it could be in your best interest to convert this loan to a fixed rate loan or pay off the variable loan as soon as possible. These loans can be in the form of mortgages, personal loans or car loans.
• Deposit products: We’re talking about certificates of deposit (CDs), savings accounts and money market accounts. When interest rates rise, deposit products can see a greater rate of return, BUT not all rates go up and they all change at different intervals. Non-Maturity deposits (funds that can be withdrawn at any time without any penalty) tend to lag rate increases by three to six months, sometimes more. CD rates are typically the ones that rise the soonest, but not all rates in every portfolio will rise. We highly recommend having a conversation with your financial institution before making any changes to your current deposit products. If you’re curious about our current rates, please reference our rates page at IHMVCU.org/Rates.
• Mortgage costs may rise: Homeowners with existing fixed rate mortgages won’t see these affects, but new homebuyers or those considering re-financing will see higher interest rates. On July 1 (the day this was published), the average 30-year fixed interest rate was 5.788%, with a 15-year fixed at 4.937% according to NerdWallet.com.
• Unemployment rises: Businesses may have to tighten their finances just like consumers during economic times of inflation or recession. Higher unemployment leads to lower consumer spending and lower output of goods and services.
• Bankruptcies, defaults and foreclosures rise: An increase in the number of people or businesses who can’t repay their debts and are seeking financial relief.
• Discretionary expenses slow down. Consumers spend less on things like cable television, streaming services, dining out, vacationing, which in turn affects the health of the communities we live in.
• Credit card debt rises: When interest rates rise, financial institutions usually charge consumers and businesses more to borrow money. Those holding a credit card with a variable APR will usually see rates rise. BUT, if you have a credit card and pay your balance off every month, this shouldn’t be a big concern. If you do carry a balance month to month or are in credit card debt, you’ll likely see your credit score fall. Why? Increased interest can lead to struggles making payments, and we know not paying negatively affects credit scores.
• Personal loan costs rise: Interest rates are still relatively low, but could always rise. If you’re considering a personal loan, check out the rate now and lock in if it’s still good.