If you’ve been waiting around for the right time to dump debt, there’s no time like right now to finally give it the boot. Why? Well, getting debt out of your life is always a smart plan. But now there’s an even bigger reason to cut it loose: Federal Reserve interest rates just went up again.
In its fight against inflation, the Federal Reserve (aka the U.S. central bank) raised interest rates seven times in 2022. The Fed’s December .5% increase boosted its target interest rate to between 4.25% and 4.5%. (FYI, rates were close to 0% at the start of 2022.)1
Keep in mind, the Fed doesn’t set interest rates for consumer loans. Instead, it sets the federal funds rate—that’s the rate that banks charge each other for short-term loans. And the federal funds rate influences the interest rates for all kinds of other loans, like mortgages, credit cards and student loans.
And more rate hikes will probably keep coming in 2023 as the Fed tries to straighten out these insane inflation rates (we’ll get into what that’s all about next).
And even though those Fed rate hikes mostly hit people who are borrowing money, they’ll impact your savings account too (but in a good way). Let’s dig into what rising interest rates mean for you and your money.
Why Does the Federal Reserve Raise Interest Rates?
We could say a lot of things here, but basically, the Federal Reserve raises and lowers interest rates to try to keep the economy running smoothly. The Fed keeps tabs on two big-time things that keep the frenzied news media in business these days—inflation and recession.
Inflation
The Fed likes to keep inflation hovering at around the 2% mark. But seeing as how the inflation rate is sitting at 7.1% as of December 2022, you can probably guess the Federal Reserve isn’t too thrilled about that.2 Hiking interest rates is an option the Fed has up its sleeve to try to slow down inflation (because people tend to buy less stuff when interest rates are high). And the word is, this most recent increase won’t be the last we see of those interest rate hikes either. So buckle up, folks!
Recession
When the Fed raises interest rates to fight inflation, the economy slows down and could fall into a recession. A recession happens when the economy is in a funk for a few months. This means unemployment is high, spending is low, and gross domestic product (the total value of all goods and services produced within a country) is negative.
When times get tight during a recession, people aren’t as interested in borrowing or spending money. So the Federal Reserve typically lowers interest rates, hoping that it’ll nudge folks to spend more.
The Fed has a balancing act on its hands. When it raises interest rates to slow inflation, it also slows the economy. And when it lowers rates to get the economy moving, it risks causing high inflation. Some blame the current high inflation on the Fed keeping interest rates too low for too long following the recession brought on by the COVID-19 pandemic.
Are Federal Reserve Interest Rates Going Up?
In a word—yup. In 2022, the Federal Reserve raised interest rates seven times.3 Oh, but it’s not done yet. The Fed plans to continue raising rates in 2023.4
What Do Rising Federal Reserve Interest Rates Impact?
Rising Fed interest rates impact one big thing—your money. Whether you’re saving your cash, spending it, or paying off debt with it, rising interest will hit your budget in some way. Here’s what the Fed’s rate hike means for mortgages, credit cards and everything in between.
Credit Cards
If you’re still using a credit card, this is where it’s really going to hit you. Rising Federal Reserve interest rates means the interest rates on those “affordable” consumer debt payments will jump up too. Anyone carrying a balance on their credit card from month to month will see an interest rate spike. And if you think most people pay off their credit card each month—think again. Right now, Americans are walking around with $930 billion in credit card debt.5
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Even though a lot of folks used stimulus checks to pay down their credit card debt after the pandemic, a lot of them are starting to pull out the plastic again. From the third quarter of 2021 to the third quarter of 2022, credit card balances in America jumped by $121 billion—that’s the biggest quarter increase in more than 20 years.6
And the crazy thing is, people are already shelling out a ton of money to cover the interest on their credit cards—and that’s before this Fed rate hike. The Consumer Financial Protection Bureau estimates that Americans spend $120 billion each year in credit card interest and fees. That breaks down to about $1,000 a year for each household in America.7 Sheesh!
Long story short? Credit cards aren’t your friend. It’s time to bite the bullet, ditch credit cards for good, and pay those suckers off.
The good news is, if you’re already paying down your consumer debt as part of your debt snowball, the amount you still owe will become less and less as you keep paying it off. That means you’ll also be charged less in interest. If that’s not another great reason to take control of your debt and spending habits, we don’t know what is!
Student Loans
If you haven’t already noticed an interest rate increase on your student loans, you probably aren’t going to. Most student loans have a fixed interest rate—meaning the interest was locked in when you agreed to take out the loan. Oh, and since student loans have been paused since March of 2020, they’re definitely not being impacted right now.
Still, any new student loans taken out from this point on will fall under these new Fed interest rates. Hint: That means student loan interest rates are going to be even more insane than they were before! That’s just another good reason to stop taking on new debt and save up to pay for your college tuition with cash.
Car Loans
Just like student loans, most auto loans have a fixed rate too. So whatever the interest rate was when you signed on the dotted line for the loan, that’s still the same interest you’ll pay. Federal Reserve interest rates don’t impact loan interest rates from that car you financed four years ago (before you knew better).
But let’s just say someone got caught up in the heat of an adrenaline-rush hyped up car commercial and went to take out a loan on a new car today. They’d be agreeing to these higher interest rates. Yikes. Don’t be that person. Just save up cash to pay in full for a used car. We know, used cars aren’t cheap these days. But if you look hard enough, you can still find a good deal without having to set foot anywhere near a car loan.
Mortgages
When it comes to what federal interest rates mean for mortgages, it all depends on what type of mortgage you have. Just like other loans out there, if you took on a fixed-rate mortgage (the only kind we want you to have), then you’d be safe. See, a fixed-rate mortgage is just like it sounds—the interest rate is set in stone for as long as you have that mortgage (unless you refinance). No matter what kind of craziness goes on with Fed interest rates, your mortgage interest rate isn’t budging.
On the flip side, if you have an adjustable-rate mortgage (ARM) or a home equity line of credit (HELOC), brace for impact here. Since those mortgage rates aren’t locked down, there’s always the chance they’ll go up—and that’s especially true when Federal Reserve interest rates climb.
With an ARM, you might not see a huge jump in the beginning. But when the ARM adjusts (usually annually), a two-point hike could really hurt. If you have an ARM on a $300,000 home at 4% interest right now, adding two percentage points in interest to your loan will cost you. Your monthly mortgage payment could increase by around $370. If you’re already strapped for cash thanks to inflation, you’re not going to like having to come up with an extra $4,440 a year!
Federal interest rate hikes or not, it’s never a good idea to take out a home mortgage with an adjustable rate. Why? Because it adjusts over time—and never in the direction you want it to go either. If you want to save yourself from a lot of interest rate heartache, go for a conventional 15-year fixed-rate mortgage.
But remember, don’t panic and buy a house before you’re ready just because interest rates are rising. That’s a quick recipe for a total mess. Wait until you’re 100% debt-free, have a fully funded emergency fund, and have a down payment of at least 10% (5% will work if you’re a first-time home buyer). And if you put down 20%, you’ll skip on paying private mortgage insurance.
Investments
When the Fed raises interest rates, it tends to make people (and businesses) buy less stuff. Plus, investors often take it as a sign the economy isn’t in great shape. So they don’t invest as much and sometimes even cash out some of their investments. This combo can cause stock earnings and prices to drop, and sometimes, the stock market takes a dip because of it. But here’s the positive side of that story—a stock market dip is a great time for long-term investors like you to invest while prices are low. When the market springs back, you’ll make a return on your investment!
Savings Accounts
Guess what? Federal Reserve interest rates going up is actually a plus for your savings. Those rising interest rates will give your savings some extra oomph. You’ll see interest rates bump up your rate of return on things like savings accounts and money market funds. And if you’ve struggled to save in the middle of this record-high inflation, then that’s got to be music to your ears. Just keep in mind, these interest rates won’t be life changing for your savings, but hey, every penny counts.
Translation: It always pays to save, but now it’s going to pay a little bit more.
What Can I Do About Rising Federal Reserve Interest Rates?
Okay, you definitely can’t change the Fed’s mind about cranking up interest rates, but you can make sure you’re in a good spot to deal with those interest rates. The best things you can do? First of all, don’t forget that promise we made earlier about not panic-buying a house. Once you’re sure you’re not going to do that, here are some other ways you can prepare for rising Fed interest rates this year.
Make a Budget
If higher Fed interest rates put you on edge, the easiest thing you can do for some peace of mind is create a budget. Budgeting each month will give every dollar a job to do and put you in the driver’s seat of your spending. Do you really need all those subscription services for streaming TV? How about that weekend getaway you had coming up? Look at your budget and see where you can trim back your spending.
Pay Off Your Debt
If you’re swimming in consumer debt—pay it off! According to the latest numbers from the Federal Reserve, household debt in America has reached $16.51 trillion. And $930 billion of that total alone is credit card debt.8
Fired up to get rid of debt forever? Good! The best way to pay off your debt is to use the debt snowball method. That’s where you pay your debts off from the smallest amount to the largest amount (don’t worry about the interest rate). Pay everything you can on the smallest balance while making minimum payments on the rest of your debts. Once you pay off that smallest debt, take what you were paying on it and put that toward the next-smallest debt on your list. The snowball keeps growing as you pay off each debt. Don’t stop until you’ve paid off everything and are debt-free!
Keep Saving
Once you’re out of debt (everything except your home), keep on saving up for your fully funded emergency fund of three to six months of expenses. Thanks to rising interest rates, your savings account will grow a little bit more than it did before. Take advantage of that higher interest rate working in your favor!
What Do Rising Federal Reserve Interest Rates Mean for My Money?
Long story short? The Fed has raised interest rates, and it’s going to keep on raising them to try to get inflation to chill out. And rising Fed interest rates just mean that the price of taking out debt (and keeping it around) is about to cost you a lot more. So use that inside scoop and get rid of your consumer debt for good. And if you’re already debt-free—even better! It’s time to make saving your top priority then.
Wherever you land in your money journey, Financial Peace University is the proven plan you need to take control of your money! And the best part? When you make a plan for your money and kick debt out of your life, rising interest rates won’t keep you up at night anymore. Now that’s peace!
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About the author
Ramsey