Interest rates can significantly affect your finances, whether you have loans, credit cards, or savings accounts, but it’s not always for the worst. Many people assume that rising interest rates are bad, but that isn’t entirely true in every instance. In this article, we’ll discuss what interest rates are, how they’re determined, and what you can do to manage your finances during a period of rising interest rates.
What are interest rates?
An interest rate is the amount of money a lender charges if you borrow money in the form of a loan or a credit card. A bank also gives you interest if you deposit funds into certain savings vehicles such as a savings or money market account or a certificate of deposit (CD).
Interest rates can be fixed or variable. A fixed interest rate is where the interest does not fluctuate during the loan term or line of credit. A variable interest rate may increase or decrease as the market interest rates change. Various factors, including inflation, economic growth, and central bank policy can influence these changes.
How are interest rates determined?
The market forces of supply and demand primarily determine interest rates. Interest rates tend to increase when there is a high demand for borrowing money, but they also tend to decrease when there is a low demand for borrowing money.
The Federal Reserve, the central bank of the United States, can also influence interest rates through monetary policy. By adjusting the amount of money in circulation, the central bank can affect the money supply in the economy, which can, in turn, impact interest rates.
The Fed will increase interest rates to calm an economy that is in overdrive or lower rates to stimulate economic activity. The rate of interest is about supply and demand. If there is a decrease in the need for credit, such as during a recession or economic downturn, then borrowing costs will be lower, and consequently, so will interest rates. But if there is an increase in demand, those rates will also increase.
How do increasing interest rates affect your finances?
The impact of rising interest rates on your finances will depend on your individual situation. Here are a few ways that increasing interest rates can affect you:
- Loans: Your monthly payments may increase as interest rates rise if you have a variable interest rate on a loan, such as a mortgage or a home equity line of credit (HELOC). If you have a fixed interest rate, your payments will remain the same for the life of the loan, which saves you money in the long run.
- Credit Cards: Since most credit cards have a variable interest rate, your interest rate and minimum payments may increase. This can make it more difficult to pay off your balance and may result in carrying a balance from month to month.
- Savings Accounts: As interest rates increase, your savings account’s annual percentage yield (APY) may also increase. However, it’s important to note that many banks may not pass on the full increase in interest rates to their customers.
What can you do to manage your finances during a period of rising interest rates?
Here are a few tips to help you manage your finances during a period of rising interest rates:
- Pay down debt: If you have variable interest rate loans or credit card debt, consider paying down your debt as quickly as possible to avoid paying more interest.
- Refinance loans: If you have a variable interest rate loan, you may want to consider refinancing to a fixed rate loan to avoid future interest rate increases.
- Shop around for savings accounts: Look for savings accounts that offer competitive interest rates. Consider online banks, which often offer higher interest rates than traditional ones.
- Invest in stocks and bonds: While investing in stocks and bonds carries risk, it can also provide higher returns than savings accounts and other low-risk investments.
The bottom line
Increasing interest rates can significantly impact your finances, from loans to savings accounts. By understanding how interest rates work and taking proactive steps to manage your finances, you can minimize the adverse effects of rising interest rates on your financial situation.