What increases the interest rate of a loan?

Borrowing money is getting more expensive. But saving is getting more lucrative. And to top it all off, the world might be on the brink of a recession.

There’s a lot going on right now, and the Federal Reserve seems to have a hand in all of it. 

The country’s central bank has raised its key interest rate several times this year, and it announced another 50 basis point rate increase Wednesday in an attempt to tame the hottest inflation in four decades. The cumulative effect of this has a bigger impact on your wallet than you may realize, and more interest rate hikes may be on the way. 

“Americans’ bottom line is diminishing. Household income is diminishing because of inflation, so we will see people relying more on credit cards and loans to offset that cost,” says Natalia Brown, chief client operations officer at National Debt Relief, a debt settlement company. “It’s really going to be difficult to find loan products with low interest rates, and it’s going to be that much harder to pay back.” 

The Federal Reserve and Your Money

The Fed was set up to help the United States economy run smoothly by keeping an eye on several economic indicators, such as unemployment, consumer prices, and gross domestic product (GDP). 

But when things don’t look so hot in the economy, the Fed can tailor its monetary policy to encourage or discourage people from borrowing, spending, and investing. This year, for instance, the Federal Reserve has been trying to combat skyrocketing inflation by raising interest rates. 

The issue is the Fed’s tightening is not working as intended so far and has had a “ripple effect throughout the entire economy,” says Sara Kalsman, a certified financial planner at Betterment, one of the largest robo-advisors for online investing. 

Inflation is still high and interest rates are rising, putting Americans in a tough situation financially. That could have the effect of slowing down demand and spending for both consumers and businesses, says Kalsman. 

“It’s difficult to predict how long this inflationary environment is going to last, but a lot of folks are concerned,” Kalsman says. “This is going to directly affect consumers through higher credit card rates, higher interest on car and business loans, and eventually mortgages as well.”

4 Ways the Fed Rate Increase Affects Your Money

Every aspect of your finances is subject to the Fed’s influence. If you’re wondering how exactly, here are four examples — from your savings and debt to your buying power and your job security:

Borrowing Money Is More Expensive

When the Fed increases interest rates, it becomes more expensive to borrow money. It means higher rates for credit cards, auto loans, and any industry that relies on financing. That’s painful for consumers, especially those relying more heavily on credit cards or loans.

Households are less willing to spend as a result, and businesses don’t have as much access to capital to grow or expand their businesses. What’s worse, businesses typically pass on those extra costs, making it a “double-edged sword” for consumers, says Brown.

“The average consumer doesn’t realize that there is an impact on their everyday spending,” says Brown. “When your dollar doesn’t go as far, you may not realize it until you get to the cash register.”

With interest rates rising, you’ll want to try to borrow less and work on paying off any debt as fast as you can. Brown recommends prioritizing high-interest debt, like credit cards, since they come with double-digit interest rates. Consider a balance transfer credit card to get an interest-free breather, as long as you have a plan in place to pay off your balance in full by the end of the introductory period.

One thing to look out for: Credit counseling. Many nonprofits offer one-on-one financial advice for free or at a low cost and can help you figure out a plan to pay down debt. It’s a much better option than debt settlement plans, which put your credit at risk and can be costly. 

Expect to pay more on interest if you’re planning to use financing to make a large purchase like a house or car. While that’s not ideal for consumers who may be in the market for a house, Kalsman says you shouldn’t time the market. If it makes sense for your financial situation to buy a house and you can afford that monthly payment, even with a higher rate, you should move forward with your plan, she says. 

Mortgage rates are changing

The Federal Reserve just increased interest rates. That might cause shifts in mortgage rates. Shop around and find a rate you can afford now.

The Fed doesn’t directly affect mortgage rates, but the federal funds rate and mortgage interest rates are driven by similar macroeconomic forces. Mortgages tend to track longer-term debt like the 10-year U.S. Treasury note, while the federal funds rate tracks more directly shorter-term debt like credit cards and personal loans. The Fed’s move could drive highly volatile mortgage interest rate changes. Mortgage rates are around 6% right now, a level unseen since 2008, and it’s hard to predict exactly where rates will end up this year. 

In the market for a car? That’s a different story, according to Kalsman. 

“Wait to buy something like a car if you have that luxury,” she says. “There’s a huge shortage of supply out there in the car market with almost no new vehicles on the lot. It could be really difficult to find what you’re looking for and then certainly much more expensive at this time.”

Bigger Earnings for Savers

If you don’t have a savings account, now’s the time to open one to build your emergency fund.

Interest rates on savings and CD accounts are rising because of the Fed’s rate hikes, which means greater earnings on your savings balances and a few more dollars back into your pocket. 

Having an emergency fund can help you if unexpected expenses and periods of financial instability arise. Experts generally recommend saving anywhere between three to six months’ worth of expenses, but even saving just a few dollars a week can go a long way over time. If you already have a well-stocked emergency fund, consider increasing your savings if you can afford to. Your money isn’t going as far right now since inflation keeps pushing prices higher.

You should also be strategic about where you keep those savings. High-yield savings accounts offer solid returns on your savings and allow you to easily pull that money out for emergencies. Online-only banks, neo-banks, or divisions of regional banks tend to offer more competitive savings rates because they don’t have to factor in the costs of physical branches. 

Shop around for rates and consider other important factors like fees, minimum deposit and balance requirements, and withdrawal options when choosing a savings account. 

It Could Trigger a Recession and a Rise in Unemployment

While the Fed has been pursuing a “soft landing” for the economy — lowering inflation toward 2% without triggering a recession — many worry a recession is on the way. 

Many experts predict the bank’s benchmark federal funds rate will continue to rise throughout the year until inflation recovers, with CFP Kimberly Howard saying “we have a long ride” still to go and “a lot of pain ahead.” 

The risks are high, and timing is everything. If the Fed raises rates too high and too quickly, it could cool demand so much that the economy tips into a recession. Higher interest rates make debt costlier and borrowing harder — for both consumers and businesses. 

“Everyone is going to be spending more money, and some people will not have access to money that they might need just to continue living their life as is,” Brown says.

That could lead to widespread layoffs, pressure on the stock market, and financial distress for millions of Americans. Many already feel like the U.S. is in a recession, even if it’s not official — and are bracing for the worst. 

Big tech firms from Apple to Google have announced that they’re slowing hiring plans. Other companies have announced layoffs. The labor market as of August was still near a record high, but unemployment researcher Andrew Stettner predicts the job market a year from now will be weaker.

“The job market is a lagging indicator,” Stettner says. “Right now, things are fine, but it will slow down.”

Increased Volatility in the Stock Market

Investors tend to panic when the Fed takes drastic action, and that translates to more volatility in the markets. There will likely be more downward pressure on the stock market in the coming weeks and months, but the Fed’s decision to raise interest rates shouldn’t steer your long-term investments off course. 

If you zoom out, historical data shows that the stock market always rises over time, and the best-performing portfolios are the ones that have the most time in the market. With that in mind, the best response is to stay the course and keep investing if you still have a long time before you aim to retire or reach financial independence, regardless of what the market is doing. 

If you’re close to retirement, you may want to begin your transition to more conservative investments and determine the best time to access the funds in each account or plan. Stick to the , which suggests withdrawing only 4% of your retirement savings during your first year and then adjusting for inflation in the following years. If you follow the rule, your nest egg will likely last at least 30 years, experts say.   

Prioritize low-cost, broad-market index funds as they are the most effective way to build wealth over time and always maintain a long-term mindset. 

The Bottom Line

The common mantra “don’t fight the Fed” has taken on a new meaning this year. Instead of agonizing over the fate of the economy, put your financial future into your own hands. Start by going back to the basics and making small but impactful money moves, like adjusting your budget, building an emergency fund, and paying down debt. 

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