It's not uncommon for members to have questions about interest rates and how they are impacted by changes in the national or global economy. When there's a news story about economists speculating that rates will go up again, it can be hard to understand exactly what that means on a personal level.
Interest rates had been near zero for almost ten years - since the financial crisis of 2008. Now that there's been steady and consistent signs that the economy has turned around, the board of the Federal Reserve has been raising rates again. But what does that mean for you?
Let's start with some of the basics and then we'll discuss how you may be directly impacted by changing interest rates.
What is "the Fed"?
"The Fed" can lead your imagination to men in suits with sunglasses and earpieces, but what is it really? The Federal Reserve System (the Fed) is the central bank of the United States. It was created by Congress with the purpose of creating a stable financial system for the nation. One common misunderstanding is that people sometimes say the fed prints money. However, only the treasury department has the ability to physically print bills.
So, what do they actually do? A major role of the the Fed is to set the fed funds rate, which is the interest rate that banks and credit unions use to lend balances to other banks and credit unions over night. Why would they do that? Financial institutions are required to have a certain amount of money in reserve, so they frequently make overnight loans to each other to meet their requirements. This impacts their operations, so it can trickle down to you as the borrower or saver at the bank or credit union.
What are we talking about when we discuss interest?
To us as individuals, interest is money that is paid regularly on either money that is saved or money that is borrowed. Let's break that down. Whenever we save money in an account, we earn interest because we've made our money available for the bank or credit union to invest in a loan to another member. If we agree to save our money for a longer period of time, like in a certificate, we typically earn a higher interest rate.
Additionally, whenever we borrow, interest is the money we pay to be able to spread out the payments over time. If we buy a car, for example, part of our monthly payment goes to the cost of the car (principle) and a part of the payment goes to the delay (interest).
How does the Fed affect your interest rates?
When the Fed changes the fed funds rate, it impacts banks and credit unions by changing the rate at which they lend money to each other. Banks and credit unions then set the rate they are paying or charging consumers for savings and loans.
Which direction rates go is dependant on some different economic factors. When the economy is strong and growing, the fed will consider raising rates. This shifts people from spending and borrowing mode to saving mode because it becomes more expensive to borrow and more beneficial to save.
The opposite is true when the economy is slowing or stagnant. That's when the fed will consider lowering rates to get consumers to spend more and borrow for new purchases.
Ultimately, the Fed is trying to maintain a stable financial system. If signs show that things are getting too far off from center in either direction - inflation, unemployment, GDP growth or decline - they can try to influence things through a rate change.
How are you impacted?
Higher rates mean you are paying more for your debt, and lower rates mean you are paying less. However, not all debt is the same. Some loans have a fixed rate, meaning your rate will not change as long as you continue to pay according to your terms.
Others have a variable rate, meaning they have the ability to change. But just because the Fed raises the fed rate doesn't mean that variable rates will immediately go up. We recently experienced a Fed rate increase when mortgage rates went down. Over time, the next trend for all rates is likely to be up - in part because they are so low there isn't anywhere else to go!
You'll want to check the terms of your existing loans so you know what you currently have. Mortgages, student loans and credit cards are common examples of loans that can be either fixed or variable. When considering taking out a new loan, expect that they will be more expensive in the near future than they have been during the recession. And for large loans for expenses like a home or education, those higher interest rates will have a big impact on the interest you pay over their long lifetime.
Higher rates also impact refinancing. In recent years, many people refinanced their home and auto loans to have low, fixed rates. If you haven't done so, consider options while you can still lock in a low rate.
Savings and Deposits
Members who want to save more will be happy as rates finally increase. A major perk of putting money into a savings, money market or certificate with a financial institution is that it is usually insured by the federal government (All FFCU deposits are federally insured up to $250,000 by the National Credit Union Administration). This is especially beneficial to people who are closer to retirement and don't want to invest in something riskier that may lose its value. However, savers have struggled for years now to earn interest on savings account deposits. As rates look up, banks and credit unions will start to pay more for money that is being deposited.
Keep in mind that each institution will vary in what they actually pay to account holders for their deposits. If you are concerned about earning the most for your money, make sure you compare your options and consider whether you are willing to put your money in a certificate or money market that has limited access, but will pay you more.