On March 16, 2022, the Federal Reserve (AKA the Fed) raised interest rates for the first time since December 2018 in a move to fight inflation (e.g., rising prices at the gas pump and checkout counter at the market). And this appears to be just the first of many this year, as policymakers project there will be six more similarly sized increases (0.25%) in 2022.
How does raising interest rates slow down inflation? When it costs more to borrow, fewer people spend money on things like homes and cars, and fewer businesses expand or buy new machinery. These spending pullbacks mean fewer workers are needed, leading to slower wage growth and further cooling off demand for goods and services (which lowers prices).
When the Fed’s strategy works, higher rates pour cold water on the economy and slow down inflation.
That’s the 10,000-foot view of how rising interest rates fight inflation, but what impact will this have on everyday Americans’ personal finances? Let’s take a look at how rising interest rates affect:
Let's dig in.
Mortgage payments
Rising interest rates affect different types of loans, including mortgages.
Mortgage rates are based mainly on the 10-year U.S. government bond yield, which started moving higher when the Fed began to signal higher rates were coming. This has pushed the average rate on a 30-year fixed-rate mortgage to over 4% for the first time since 2019, which is about 1% higher than it was in early 2021.
One percent seems like a small number, but it can have a big impact on a mortgage, increasing both the monthly payment amount and the lifetime cost of the loan.
For example, a family shopping for a mortgage amount of $300,000 with a fixed rate of 3.5% for thirty years will pay about $485,000 over the life of the loan, with nearly $185,000 of that amount being interest charges. Their monthly payment will be around $1,340.
Raising the interest rate to 4.5% will significantly increase the total amount the family will pay for their home over 30 years ($547,000) and the amount of interest they’ll pay over the life of the loan ($247,000). Their monthly mortgage payment will jump to around $1,520.
The increase in their costs may cause the family to delay purchasing a home or buy one that requires a smaller mortgage, which will reduce the amount of money in the economy (inflation fighter).
[ Related: 2022 new homeowner checklist ]
Auto loans
Car loans also have fixed rates tied to Treasury yields, meaning that rising rates might lead people to compromise on the model they buy, forego buying the shiny new model in the showroom altogether, or buy a used car (limited inventory pushed used car prices higher by over 40% in 2021). Interest rates for auto loans are fast approaching 4%.
Credit cards
According to WalletHub’s March 2022 report on credit card offers, the annual percentage rate (APR) for people with good credit was 18.98%. An increase in interest rates can affect a credit card’s APR, which had already been edging higher as banks covered the costs of their popular rewards and points programs.
Higher credit card rates also help curb consumer spending because of the increased interest that has to be paid on goods purchased and higher monthly minimum payment levels. Hence, the plastic stays in the wallet more often (another inflation fighter).
Student loans
Americans with federal student loans for the 2021-2022 school year won’t be impacted by rising interest rates — yet.
Interest rates for federal student loans are tied to the 10-year Treasury note. The rates are fixed for the life of the loan, with the current rate being 3.73% for direct subsidized and unsubsidized undergraduate loans through June 2022. Rates are set in May each year, so the recent rate increase could impact loans distributed for the upcoming academic year.
Rates for private education loans could feel a more immediate impact from the rising interest rates set by the Fed. Private student loans charge either fixed rates, which remain level, or variable rates, which can increase or decrease depending on the lender.
High-yield savings accounts & certificates of deposit
The low-interest-rate environment Americans have lived in for the past three years led many people to look for alternative investments and a higher yield, which also carried higher risk. Rising interest rates will very likely lead to a bump in rates for CDs and high-yield savings accounts. This will not likely lead to a mass exodus of crypto and equity investors over to CDs, but it may encourage more conservative investors to reevaluate offerings from their local banks.
[ Related: 2022 financial trends to watch ]
Stocks
Rising interest rates can negatively impact the stock market. They increase the cost of doing business for both public and private companies, which can lead to lower earnings and revenues for public firms, affecting their growth rate and, ultimately, their stock values.
The more immediate impact of a Fed rate increase on the stock market is increased volatility. Traders often quickly sell off stocks and move into more defensive investments when a rate hike is announced, which can lead to the herd mentality kicking in and a rush for the exits, instead of waiting for the higher rates to work their way through the economy and lead to sustained economic growth.
Bonds
Bonds are particularly sensitive to changes in interest rates. As rates rise, bond prices decline. New bonds coming on the market that offer investors higher interest rate payments become more attractive, leading to a decline in the price of existing bonds.
Short and medium-term bonds are less sensitive to rate increases than longer-maturity bonds that lock into rising rates for more extended periods. However, short-term bonds provide less income earning potential than longer-term bonds.
The bottom line
Rate increases should be taken with a grain of salt. While they can dampen consumer enthusiasm, they can also be a catalyst to reduce credit card debt, refinance variable-rate mortgages, and rebalance investment portfolios. Americans who focus on their long-term financial goals and reduce their debts will weather the changes just fine.
The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.
