The Federal Reserve raised its benchmark interest rate four times in 2022, including 0.75% increases in both June and July, and interest rates will likely rise again.
When the interest rate changes, there are real effects on how both businesses and consumers make purchases. To understand how interest rates affect your personal money, you need to understand exactly how it works.
What is the interest rate?
The interest rate is the rate you pay to borrow money. Common examples include a mortgage, auto loan, student loan, or credit card. When the lender lends money, he profits from the interest paid. Ultimately, these rates will affect the total price you pay once the loan is paid off. Since no two loans are exactly alike, it can be difficult to decide which type of loan is best for you. Before you borrow, make sure you understand how the interest rate affects the final return amount.
Why is the Federal Reserve raising interest rates?
Interest rates are the Federal Reserve’s main tool for fighting inflation. The Federal Reserve can speed up or slow down the economy by moving interest rates lower or higher. When inflation is too high, the Federal Reserve will usually raise interest rates to help slow the economy and lower inflation. When inflation becomes too low, the Federal Reserve cuts interest rates to stimulate the economy and help raise inflation. By raising interest rates, and thus making purchases more expensive, the Fed hopes to slow Americans’ willingness to spend money to combat rising inflation.
How interest rates can affect you
No matter your age, whether you’re buying your first home or approaching retirement, higher interest rates can affect you.
While the prime rate is not directly related to the price of your mortgage, those looking to buy a home now are hit hardest. Mortgage rates rose along with inflation throughout the spring and summer. Look at a $400,000 loan as an example of this increase. A few months ago, paying off this loan would have been about $1,700 per month. Today, however, payments have increased by nearly $800. With this massive increase and rising house prices, mortgage applications are down about 15% from this time last year.
If you are looking to buy a home or a car and want to save money, try to secure a long-term loan rate as soon as possible before it goes up any further.
If you’re past your new home buying days and are looking to retire, interest rates can affect you, too. Interest rates do not directly affect the stock market, but they can cause it to fluctuate. Rising prices have a significant impact on bond portfolios. When prices rise, the price of bonds falls. Any long-term bonds you have can feel this effect most, while short-term bonds may be less affected. In the meantime, if you are considering an annual stipend, higher interest rates may be good for you.
Having a diversified portfolio that includes stocks, bonds and the like is your best tool to sustain growth through higher interest rates. Of course, before making any big investment decisions, meet with a financial advisor to discuss your options.
Regardless of whether interest rates are going up or down, working with a financial advisor is always a good idea. From accumulating retirement savings to planning your financial future, they are the experts. Don’t be afraid to ask questions. It’s your money, and they want to do what’s best for you!
Founder and CEO of Drake and Associates
Tony Drake is a certified financial planner, founder and CEO of Drake & Associates in Waukesha, Wisconsin.Tony is an investment advisor and has helped clients prepare for retirement for more than a decade. He hosts the Retirement Ready Radio Show on WTMJ Radio every week and is shown regularly on television stations in Milwaukee. Tony is passionate about building strong relationships with his clients so that he can help them build a solid plan for their retirement.