Rising Interest Rates: How They Impact Your Finances

What does a rate increase mean, and what can you do about it? See tips and answers below.

Rising interest rates can be a cause for worry, but rate changes are nothing new when it comes to economic cycles. What’s more important is understanding how your personal finances may change when there’s a Fed interest rate increase.

With this knowledge, you can make informed decisions to strengthen your financial situation and explore the best options for spending, saving, and investing.

What Does a Fed Rate Increase Mean? 

The Fed rate is the target interest rate set by the Federal Reserve. It governs how much banks and other financial institutions charge to lend money to each other. It influences interest rates on loans including credit cards, mortgages, and auto loans as well as interest paid on new bonds and interest earned in savings accounts.

The Fed Rate and Inflation

The Fed uses interest rate changes to control inflation. The Federal Reserve has determined that a 2% inflation rate is ideal for a stable economy. In 2022 and 2023 (so far) we’ve experienced record inflation rates as high as 9%+. Therefore, the Fed has made several interest rate increases to try to reverse the trend. 

So far, the current 4.5 to 4.75% Fed target rate has impacted interest on many consumer lending products, like home and auto loans and credit cards.

The good news is, along with rising interest rates, you may also earn more interest on savings accounts and Certificates of Deposit (CD). These rate increases can help you keep pace with inflation, since they help you earn more with the money you have.

How Do Interest Rates Affect Inflation?

If interest rates rise, the assumption is that people will become more reluctant to borrow and spend. At the same time, they’ll be more motivated to save money in banks because of the better interest earning opportunities. In theory, this will slow down the economy and help reduce prices and inflation.

Why Do We Have Rising Interest Rates?

From March 2022 through February 2023, the Fed raised interest rates eight times to try to control inflation, taking rates from 0.25% to 4.75%. The 4.75% rate is the highest Fed rate level since 2007. 

The good news is, inflation has likely peaked. The year-over-year increase from January 2022 to January 2023 was 6.4%. Compare that to June 2022 when the inflation rate was 9.1% for the previous 12 months.

That said, because inflation is still elevated, Fed Chairman Jerome Powell says he anticipates additional increases to the Fed rate for 2023, most likely in smaller 0.25% increments.

How Rising Interest Rates Make Borrowing Money More Expensive

What does the Fed rate mean for your everyday finances? It costs more to borrow money during rising interest rates. You’ll feel this in several ways:

New Credit Card Debt Becomes More Expensive

The average credit card rate reached its highest point in February of 2023, going over 23%. It’s possible to have a lower APR than that if you have excellent credit and choose a credit card that offers a competitive rate. But even if your FICO score is 800+, you’ll still pay more than you did a year or two ago. 

Pro Tip: The best way to handle higher interest is to avoid it altogether by paying your balance in full each month. 

Existing Credit Card Debt Becomes More Challenging to Pay Off

If you have a variable-rate line of credit (typical for most credit cards) any balance you carry becomes more costly. That can make it more challenging to pay off your debt. 

Pro Tip: Try calling your credit issuer and asking them to lower your rate. If you’ve kept your account in good standing, they may agree.

Higher Monthly Payments for New Car Loans

Auto loans are another type of consumer loan that will see a spike in interest rates when the Fed rate is raised. It wasn’t too long ago that some people could qualify for a car loan with 0% (or close to it) interest. However, by the third quarter of 2022, the average interest rate was 5.16% for new vehicle loans, and 9.34% for used. 

Pro Tip: Taking good care of your current vehicle or asking for a lease extension can help buy a little more time during rising interest rates. That can give you a buffer until prices come back down. 

Your Home Buying Power Will Go Down

You may wonder, are mortgage interest rates going up? The answer is yes. Mortgage rates typically go up with Fed rate increases. While we saw historically low mortgage rates under 3% toward the end of 2020, 30-year fixed rate home loans went up above 6% by early 2023.

A 3% interest rate difference on a loan that’s hundreds of thousands of dollars can mean hundreds of dollars difference in your monthly payment. 

For instance, a 30-year fixed rate mortgage for $500,000 at 3% interest would cost $2,108 per month. That same loan at 6% would hike your monthly payment to $2,997. If you wanted to stick closer to $2,100 per month in payments, you’d only be able to borrow $350,000 which is a drop in purchasing power of $150,000!

Pro Tip: Be sure to keep your credit healthy so you can qualify for the lowest rates possible.

How Do Interest Rates Affect Savings Accounts?

On the plus side, a Fed rate hike usually results in banks and credit unions offering more competitive interest rates for savings accounts. 

Savings Accounts Earn More Interest

While you may have become accustomed to savings accounts earning just a few cents per month, today there are many high-yield savings account offers in the 4% range, thanks to Fed interest rate increases. 

Pro Tip: When you notice rising interest rates, check what your savings account is earning. Consider moving some of your cash to an online high-yield savings account, which typically has more competitive rates than brick-and-mortar banks.

New CD Rates Increase

If you want to earn guaranteed interest on a chunk of money that you can afford to tie up for a period of time, you can expect CD rates to be more competitive when interest rates increase. In early 2023, some advertised CD rates were over 5%.

How Do Interest Rates Affect Stocks and Bonds?

Higher interest rates generally put downward pressure on stock and bond prices. For example, stocks and bonds tend to be less attractive investments when interest rates for savings and CDs are high. That’s because you can earn decent interest without assuming the usual market risks. In addition, company profits can come under pressure when the cost of borrowing rises which can put downward pressure on stock prices. And bond prices tend to decrease when new bonds are offered at higher interest rates.

A Note About Stocks

Don’t hold back on your retirement contributions when interest rates rise. You have compound interest on your side, and you’re likely to see a higher rate of return over time than you’d get with savings accounts or CDs.

Bond Strategies Differ

If you own existing bonds at lower rates, those bonds are not as attractive to buyers given that buyers can get new bonds with higher yields. Because of that, it might make sense to hang onto existing bonds until maturity when you can get your full face value back. On the other hand, swapping out a low interest bond, even if the price has dropped, could make sense if the interest you’ll receive on a new bond is substantially higher. 

If you’re in the market for a safe investment with an attractive interest rate and you don’t need access to your funds for at least a year, consider Series I bonds. These are tied to the inflation rate, and new rates are set every six months. So, when inflation is high, you’ll get a higher rate of return. You can purchase up to $10,000 in I bonds per year per person. Learn more in our article about how I bonds work.

Trying to reduce your losses during times of high inflation? See our article on the Best Places to Put Cash.

How to Protect Yourself When Interest Rates Go Up

Now that you understand what happens when interest rates rise, there are some strategies that can help you avoid higher borrowing costs and maximize earned interest.

Look for Fixed-Rate Options for Debt and Loans

In a rising rate environment, people with variable-rate products will see their bills shoot up. Choosing products with fixed rates can protect you from future increases. Just keep in mind that if you’re considering refinancing or consolidating, do it only if there’s a financial benefit. (For example, qualifying for a lower rate than you’re already paying, or lowering your monthly bill.)

Make a Higher Down Payment

Paying cash or a higher down payment on a car or home can help keep your monthly payments more manageable when interest rates are high.

Protect Your Cash From Losing Value

As inflation rises, the spending power of your dollars goes down. By taking advantage of high-yield savings accounts, money market funds, Series I bonds, and CDs, you can gain some interest on your money to help offset the loss of purchasing power.

Prioritize Paying off High Interest Debt

Aim to knock out any loans or credit lines over 7%, like credit cards and personal loans, especially if they have variable interest rates. Start with a micro goal (like paying off $5,000 of credit card debt in a year). Try tackling the highest-interest-rate debt first, or the smallest balance first — whichever approach is most appealing to you. Then pay minimums on the rest until you move on to tackle the next debt.

Tip: Consider a balance transfer credit card with a temporary 0% APR to pay less interest. Some cards provide this rate for as long as 18 months.

Keep Investing in Your Retirement Plan

Playing the long game means you should keep investing when interest rates rise, and avoid panic-selling during times of turmoil. 

Stay Calm and Stick to Your Financial Plan

Sticking to your plan is important, even when factors out of your control come up. But it’s also smart to reevaluate every few months, yearly, or if your priorities shift, and seek professional guidance as needed, so you can make adjustments along the way.

How Interest Rates Affect Inflation and Recessions

Now that you have an individual gameplan, what about the big picture? Do rising interest rates mean there’s a recession coming?

In theory, raising interest rates leads to a reduction in consumer spending, which decreases demand enough that everyday goods will fall in price. If rates rise quickly, a reduction in demand could lead to job cuts and reduced product output. Eventually, this could lead to a recession. So far, unemployment rates have remained low (despite some high-profile tech layoffs), signaling that a recession is not yet imminent.

The Bottom Line

Rising interest rates can affect you in several ways — some good, and some bad. Taking financial responsibility and increasing your awareness by using intuitive financial planning software that tracks investments, savings, debts, and expenses can help keep your plan on point.