The Fed and You: How Interest Rates Affect Your Personal Finances
The future of the ‘federal funds’ rate does not only carry important consequences for Wall Street, but it also affects you too. Before the momentous decision taken by the British people to leave the EU, interest rate hikes appeared to be on the horizon for Janet Yellen and the Federal Reserve. However, uncertainty has returned after Brexit, as an increase in interest rates is now very unlikely in the near future.
But if and when a hike comes, what does it mean for you and the millions of others who don’t work on Wall Street?
The probability of a federal funds rate hikeat the Fed’s next three monthly meetings has collapsed to 0%, and traders are assigning a less than 8% chance of a rate increase at all this year… Traders are assigning a 10% probability to the Fed cutting interest rates at its July meeting, and a more than 20% chance of a rate cut at subsequent meetings later this year and in early 2017. – Jen Wieczner
Investors, bankers, journalists and politicians hang on every one of Janet Yellen’s words to get any sort of hint for what the future holds for the US economy. While you should not overreact to the constant media attention, it should serve as a reminder that the future of interest rates can affect your personal finances. The ‘federal funds rate’ – the rate banks charge each other for short-term loans – steers the economy of the US. It serves as a benchmark (directly or indirectly) to determine other rates that affect your personal finances.
Yet, seven in ten Americans do not understand the Fed’s interest rate policies and 24% of Americans could not identify the most powerful person in the Federal Reserve Board, Janet Yellen.
Don’t be quick to dismiss and underestimate the importance of the federal funds rate on your personal finances.
Borrowers vs. Savers
Whether low interest rates benefit you or not is directly dependent on whether you are a borrower or a saver.
Borrowers benefit from a lower federal funds rate because they save money from paying less on their interests (e.g. loans and credit card debt).
Yet, while borrowers benefit from low interest rates, savers don’t. A lower federal funds rate means the money you have saved will grow at a slower rate. Your savings account will be the greatest loser if the Fed decides to hold out on interest rate hikes. That’s why it’s been hard for the last decade to find a savings account that pays more than 1% interest on your money.
“The Federal Reserve has its fingers in your pocketbook to a greater degree than the IRS.” – Michael Reese
Although the federal funds rate does not affect mortgage rates directly, it indirectly changes how much you should pay for your loan. With interest rates remaining low amid uncertainty, experts estimate mortgage rates to remain at all-time lows.
See this as an opportunity to finally become a homeowner or to refinance your fixed-income mortgage. In the past quarter alone, according to a Compass Point Report, mortgage applications rose by 17%.
Changes in the federal funds rate will not affect over 90% of student loans since they have a fixed interest rate (meaning it is locked in).
Nonetheless, like with mortgages, this can be a good opportunity to refinance your student loan debt. Be weary, though, and make sure you know exactly what you are getting yourself into. If you decide to refinance your fixed rate student loan with a private lender, then you will let go of federal income-driven repayment plans and public service loan forgiveness.
Like with mortgages and student loans, the effect interest rates have on your credit card is dependent on whether or not your credit card contract carries a fixed or variable interest rate.
If your credit card has a fixed interest rate, then interest rate changes will most likely have no effect on you. BUT, be weary of changes in your fixed interest rates. Banks are allowed to change ‘fixed’ interest rates on your card as long as they notify you.
If your card has a variable interest rate, then you will most likely benefit from current low interests. If the interest rates remain relatively low, this typically carries over to low credit card interest rates (APR).
Your portfolio should be the one exception to being overly vigilant to interest rate changes. Maintain a diversified portfolio and do not change your long-term goals.
As a result of global uncertainty, experts do not expect the Federal Reserve to increase interest rates in the near term. As a consumer, it is important to understand how interest rates affect your personal finances. As of today, take advantage of low interest conditions that will most likely continue for at least a year. In spite of this, you must maintain sound financial judgment, as you should try to increase your savings and avoid risky borrowing projects regardless of interest rate movements.