You may have heard that the Federal Reserve (the Fed) has recently lowered interest rates, and that their decision could impact what you pay in interest on personal loans, credit cards, student loans, and other types of financial products.
Taking the time to understand what the Fed does with interest rates is worthwhile, not only because it could affect what you pay or earn in interest, but in large part 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, so continue reading below to get the full scoop.
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 Fed is the U.S. central bank that keeps the economy stable by controlling inflation, and they accomplish this by setting the federal funds rate.
When the fed rate is high, banks lend money at a higher interest rate because they’re borrowing money at a higher interest rate; this makes loans harder to obtain and more expensive, causing fewer consumers and businesses to borrow. Consumers generally spend less money when the fed rate is high, which causes the economy to slow down.
As you could expect, the opposite is true when the fed rate is low – banks can offer more loans at lower rates, so more consumers and businesses are able to borrow. Consumers are typically more comfortable spending money during these times, and the economy grows as a result.
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, as financial services companies typically follow the lead of banks and increase or decrease interest rates on new and variable-rate products accordingly.
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 due to lower interest rates. On the other hand, if the economy is growing too fast, the Fed may increase rates to prevent inflation; this makes the rates to borrow higher, so corporations and consumers are more likely be financially conservative during these times.
What’s the Current Federal Interest Rate?
As a response to the economic downturn the U.S. (and world at large) have experienced due to the coronavirus outbreak, the Federal Reserve lowered its target for the federal interest rate from 1.75% to a range of 1% to 1.25% on March 3, 2020. More recently on March 15th, the Fed lowered the fed rate again, down to a range of 0% to 0.25% in another effort to combat the economic repercussions of the ongoing global pandemic.
How the Federal Interest Rate Could Impact You as a Consumer
While changes to the federal interest rate impact most financial products that come with an interest or yield rate, there are exceptions. 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 in the rate could either cost 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 fed rate could increase or decrease the rates you’ll pay on both new and current accounts.
Personal loans: While the interest rates on current fixed-rate personal loans do not change, variable-rate and new personal loan interest rates could go up or down depending on the fed rate.
Mortgages: Just like personal loans, variable-rate mortgages and new mortgages may 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 only impact private student loans, as 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. If you have a lot of money saved, you could potentially earn more interest if the Fed increases their rate.
Keep an Eye of Fed Rate Changes
Keeping an eye on federal interest rate changes is not only a smart habit to adopt, but it’s also key in helping you prepare for changes that can impact your financial status. To learn more about how you can keep your finances strong and healthy, take a look at our “Understanding Credit” resources section.