Borrowing

Are Interest Rates Going Up? Here's Why You Should Care

For months, the hottest topic on Wall Street has been when and how often the country’s central bank will raise interest rates. 

At its meeting last December, the Federal Reserve (or Fed) raised rates for the first time in a year—from .25-.50 percent to .50-.75 percent. But central bankers also signaled they’re likely to raise it three more times in 2017. The next increase is widely expected to happen tomorrow. That would bring the target range for overnight rates (which banks use to lend to each other) to 0.75 percent to 1 percent.

So, why should you care?

Why a Rate Hike Matters

The so-called federal target funds rate is the range that banks use when they lend money to each other. Banks and other lenders in turn use that to determine interest rates for mortgage loans, auto loans, credit cards and other types of credit they extend to us. When the funds rate rises, you can expect to start paying more for credit because the rates of variable loans will increase, too, says Willie Schuette, National Social Security Advisor, of The JL Smith Group in Avon, Ohio.

If you have a variable rate credit card, you could see an increase in the interest you pay on it within 60 days. If you’re a homeowner with an adjustable-rate mortgage, you’ll also get hit when your loan resets.

Rates can affect not only how much you pay on money you borrow, but how much you can earn on investments like certificates of deposit—and they can have broader implications, too. Cheaper rates mean it’s easier for both consumers and companies to borrow money. If consumers borrow, and spend more, that can provide a boost to the economy (assuming we don’t get in over our heads, which can have the opposite effect). And companies can use loans to expand their businesses and hire more employees, which can be good for their stock prices as well as the economy.

Related: Wait, Weren’t Rising Interest Rates Supposed to Help Savers?

But if the economy expands too quickly, it can cause a jump in inflation—an increase in the price you pay for basic goods and services—which in turn makes your dollars less valuable. So the central bank is constantly weighing whether the economy is expanding fast enough or too quickly, as it decides whether to raise rates and take other actions. 

The consumer price index, which measures the changes in the price level of a basket of common consumer goods and services, rose at a 2.5 percent rate  from January 2016 to January 2017 and the CPI for February is expected to show inflation running closer to 3 percent. Trends like that, plus an increase in average wages and strong job growth numbers, indicate the economy is picking up and makes the Fed more likely to raise rates.  

Interest Rates and the Stock Market

Generally, it’s good news if the Fed raises rates because it signals “a healthy and growing economy,” says Tom Cassidy, chief investment officer at Univest Wealth Management Division. “But the concern about rising rates is if they increase too fast, [they could put] the brakes on the economy, which could lead to a recession.”

Cassidy doesn’t expect that to happen, though, based on the Fed’s earlier statements that economic conditions will likely warrant only moderate increases in the federal funds rate.

Chris Cook, founder and CEO of Beacon Capital Management in Centerville, Ohio, points out that even with the December increase, the range is still near historic lows. And the Fed has indicated that any increases in 2017 should be “gradual.”

So what should you do in the meantime? Stay committed to your financial goals, including saving, investing and, especially, working to pay off debt—so you’ll be prepared as your debt becomes more expensive. Beyond that, don’t worry too much about the upcoming rate hikes.

“Capital markets occasionally go through gyrations based on interest rates, but the economy is actually doing quite well,” says Jeff Reeves, executive editor at InvestorPlace. The bottom line: “If you’re running a pension fund …the Fed’s next meeting matters. But if you’re a normal American, then just chill out.”

This story was updated in March 2017.

 

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