What Do Rising Interest Rates Really Mean?

Interest rates are slowly rising for the first time in years, but what does it actually mean? Higher interest rates aren’t usually good.  Higher interest rates can change the cost of borrowing money, saving money and much more.  However, contrary to popular belief, rising interest rates aren’t all bad.

Are Rising Interest Rates Good Or Bad?

Rising interest rates can mean different things for different people. As a consumer, rising interest rates are not good. This means that you would be paying more money towards interest and keeping less of your money in your wallet. Usually for a consumer, having the lowest interest rate is the best, especially when it applies to a big purchase like a mortgage. However, for the nation as a whole, rising interest rates are a good thing. In fact, rising interest rates are a sign of economic strength.

When interest rates are low, people spend more money because they don’t pay as much in interest and have more disposable income. When people have more disposable income, they spend more money and stimulate the economy. This can lead to inflation if not properly monitored.

The Good

Saving Money

With higher interest rates, saving will be more profitable so it is wise to put your money in a savings account, especially online savings accounts that offer great rates.  The high interest rates can help you while hurting borrowers.  As interest rates rise, savings accounts could help you gain money rather than taking it away.  According to the Federal Reserve’s Survey of Consumer Finances, the average amount of savings for a US family is $40,200.

Home Prices

Even as interest rates rise and the cost of borrowing becomes more, housing prices actually fall due to more people becoming less interested in buying.

Conservative Investments

As interest rates rise, it will be much easier to get a good return on low-risk investments such as CDs or bonds.

Fixed-Rate Loans

With rising interest, any fixed-rate loan will remain unaffected, which includes current fixed-rate mortgages, student loans and car loans.

The Bad

Borrowing Money

Borrowing money will be come more expensive as interest rates rise, affecting rates that you can get for home loans, auto loans, personal loans and credit cards to name a few of the biggest financial borrowing industries.  The Federal Reserve has shown that these rates have continued to rise since they increased their target rate in 2016.  Of particular concern in a rising rate environment is your credit card debt, as well as adjustable-rate mortgages, as interest will increase on these loans.

Buying a Home

The interest on your new mortgage loan will be higher as interest rates increase.  For instance, according to the Federal Reserve, the average 30-year fixed-rate mortgage increased by 0.75% between August 207 and 2018.

The stock market

Stock prices are typically hard to predict, but a typical rule of thumb is that as interest rates go up, stock prices should fall as more people will typically invest in bonds.

United States Economy 

In a high interest rate economy, business will typically have to pay more interest on the debt they have and making it more expensive for them to invest in their business, usually resulting in slower economic growth.  This can also affect consumers in the short term, making them less likely to spend in the economy.  The biggest issue, according to the U.S. Treasury, may be the massive debt that has doubled in the last ten years.  If interest rates rise back to average levels, the interest on the debt will be the highest item in the federal budget with super high interest payments.

How Can We Prevent Inflation?

Inflation is when there is a general increase in prices and the value of the US dollar goes down.  This usually happens as a result of too much money in the economy. When there is more money and not enough goods to meet the demand, prices will naturally go up. The same goes for the reverse: if there is too much supply, prices will fall. It’s just like a store selling in season items for full price and putting other items on sale.

In order to keep inflation at bay, The Federal Reserve needs to control the spending.  If there is less money to go around, there is less demand. When there is less demand, prices drop. Following this model, The Federal Reserve will increase rates as an effort to control spending and prevent inflation, since goods will be more expensive without raising prices.  When things are more expensive to purchase, people will generally be more cautious about spending. Eventually, prices will have to adjust by becoming cheaper, or by remaining the same.

How Does This Affect The Housing Market?

The housing market is currently at an all-time high. People are making enough money, but there aren’t enough houses to accommodate everyone who wants to buy a home. With the interest rate slowly going up, we should eventually see a slow-down in home purchases, which will slowly bring down home prices over time.  If you’re looking to purchase a home but are struggling to keep up with the rise in home prices, there are mortgage options like the FHA Loan which only requires a minimum of 3.5% as a down payment.

For much of the past decade, interest rates have been at historic lows. Interest rates set by most lenders tend to go up and down based on the federal funds target rate, or the rate at which banks can borrow from other banks, which is set by the Federal Reserve. This rate has ranged from around 1% to over 19% over the decades, but in the wake of the 2008 recession, it dropped to nearly zero and stayed there for five years. This made borrowing money cheap, encouraging consumers and businesses to spend – but it also discouraged saving, because the interest on bank accounts was so low.

Since 2016, however, the target rate has been slowly but steadily rising. By mid-2018 it was back up to nearly 2% – a rate that’s still low by historical standards, but getting close to normal territory – and the Federal Reserve has suggested there are more hikes to come.

As the target rate creeps upward, interest rates on other products, from credit cards to savings accounts, are also rising. This, in turn, will have an effect on lots of things you do as a consumer – from opening a bank account to buying a home. Here’s an overview of what you should expect as interest rates continue to rise, and what you can do to prepare for it.

How do you plan for higher interest rates?

Interest rates increasing will hurt many consumer’s bottom line, but some consumers can improve it by understanding how to be prepared and what to do in a rising rate environment, using the high rates to their advantage.  If it is understood that interest rates are going to rise, consumers with credit card debt should look to pay off this as fast possible.  Further, consumers should try and avoid new loans in this type of environment as they will be locked into a higher rate.  With this, it is super important to try and lock in your interest rates now to make sure that you take advantage of the lower interest rate.  This entails looking into refinancing your mortgage if you have an adjustable-rate-mortgage to make sure that you have a fixed-rate as interest rates rise.

Saving will also be key since savings rates typically increase and you can earn more on your money in these conservative investments.  Bonds, in particular, will offer higher returns, but it is important to make sure you stick to short-term bonds, as with longer term bonds you can get stuck with earning a low rate for a longer period of time than you need to.  Finally, if you are looking into buying a home, while mortgage interest rate are higher, the price of a home could be much lower and renting higher with a lot of people unable to afford to buy a home.  With this, you should really look at the benefits of renting vs. buying a home.

The Bottom Line

It is really hard to figure out if interest rates are going to continue to rise, will stagnate or begin to go down.  This is because the Federal Reserve could halt rate hikes, reverse them or continue to increase them.  The best thing to do in a rising rate situation is to prepare for all outcomes and make sure that you plan ahead, as it’s always better to be safe than sorry.