You may have heard that the Federal Reserve (the Fed) is considering raising or lowering interest rates, and that their decision could impact what you pay on financial products like personal loans, credit cards, student loans and more.
Understanding what the Fed does with interest rates is worth it, not just because it could impact you what you pay or earn in interest, but also because it could have a strong impact on the overall economy. Knowing a thing or two about the Federal Reserve and federal interest rates can help you prepare for changes that could impact you financially.
What are Federal Interest Rates?
The federal interest rate, also known as the federal funds rate, is the interest rate the Fed uses to loan money to banks and other financial institutions. The federal funds rate is an important interest rate as it influences rates charged on mortgages, student loans, personal loans, credit cards and high interest rate bearing savings accounts.
The Fed is the U.S. central bank that keeps the economy stable by controlling inflation. It influences the economy by setting the federal funds rate — a rate that banks charge each other for overnight loans. When the Fed drops interest rates, it typically means you could pay less interest on the money you borrow and earn less on savings and investment products.
How do Federal Interest Rates Work?
When the Fed raises or lowers the federal interest rate it sends a domino effect in motion —triggering banks to follow suit by raising or lowering their prime rate. Changes in the prime rate could impact what you pay on credit cards, mortgages and certain types of loans. When the Fed raises or lowers its interest rate, financial services companies typically follow their lead and increase or decrease interest rates on new and variable-rate products.
Why does the Fed Raise and Lower Interest Rates?
The logic behind changing the federal interest rate is to help maintain a stable economy. When the economy slows down, the Fed could decide to lower the benchmark rate—making corporate and consumer borrowing easier.
On the other hand, if the economy is growing too fast the Fed may increase rates to prevent inflation—causing corporations and consumers to be more financially conservative.
What’s the current rate?
The federal interest rate was recently lowered to a target range of 2% to 2.25% when the Federal Open Market Committee met on July 31, 2019. This was the first reduction since 2008, which is a good thing – the drop in the Federal Funds Rate serves as an indicator that the economy in the U.S. is in good shape.
How the Federal Interest Rate Could Impact You as a Consumer
Changes to the federal interest rate impacts most financial products that come with an interest or yield rate. Let’s take a look at how you could be impacted by changes to the federal fund rate.
Auto loans: Changes in the fed rate impact both new and existing variable-rate auto loans. With new loans, an increase or decrease could either cost you or save you money depending on what you’ve paid on auto loans in the past.
Credit cards: Credit cards usually charge variable interest rates, so any change to the federal fund rate could increase or decrease the rates you’ll pay on both new and current accounts.
Personal loans: Variable-rate and new personal loan interest rates also go up or down with the fed rate, but the interest rate on current fixed-rate personal loans stay the same.
Mortgages: Just like personal loans, variable-rate mortgages and new mortgages can see an increase or decrease in interest rates along with the fed rate. While fixed-rate mortgages are not affected, a decrease in the interest rate could make it cheaper to borrow money from a Home Equity Line of Credit or refinance your home.
Private Student loans: Increases and decreases to the fed rate will only impact private student loans since Congress sets the rates on federal student loans.
Savings accounts: As the fed rate decreases or increases, so does the annual percentage yield on high yield savings accounts. So, if you have a lot of money saved, you could potentially earn more on interest if the Fed increases their rate.
Keep an Eye on Fed Rate Changes
Keeping an eye on federal interest rate changes is a smart financial habit to adopt. If the Fed looks like it’s going to hike rates, you may want to start thinking about consolidating high-interest rate credit card debt in advance with a fixed rate personal loan. When the fed rates drop, take advantage of it in ways that are financially responsible. Consider taking out a new low-interest rate personal loan to pay off variable interest rate credit card debt or tackle that home improvement project you’ve been dreaming about.