How does the Federal Reserve interest rate affect me?

What does the Federal Reserve do?

Behind the scenes, the Federal Reserve is quietly influencing your everyday life when it comes to borrowing, saving, and even spending. As the central bank of the United States, the Federal Reserve (or Fed) is responsible for managing the country’s monetary policy. Since its inception, the Fed has worked to steer the U.S. economy toward strong employment and stable prices.

To reach those goals, the Fed uses a powerful tool: the federal funds rate, or the short-term interest rate banks charge each other to lend funds overnight. By raising or lowering interest rates, the Fed tries to influence the cost of borrowing money, which can curb or boost inflation. When interest rates increase or decrease, the effects trickle down to you and the financial products you use daily, like credit cards, loans, and savings accounts. 

The Federal Reserve raises and lowers rates in response to fluctuating economic conditions. Typically, the Fed prefers to make gradual rate changes to minimize any ripple effects. However, major economic shocks from events such as the pandemic or soaring inflation can spur the Fed to act more aggressively.

In 2008, when the economy plunged and unemployment spiked, the Fed dropped the federal funds rate to zero-0.25%. In 2022, to combat inflation, the Fed began to raise interest rates..

In mid-March 2022, the federal funds rate was 0.25-0.50%; by the end of July 2023, this rate had increased to 5.25-5.50%, according to the Federal Reserve Bank of New York.

A change to the federal interest rate—whether up or down—could have a ripple effect in the same direction on everything from interest rates on CDs to rates on mortgages and even the prices of everyday goods. Over the same March 2022 – July 2023 time frame, per the Federal Reserve Bank of St. Louis, the average 30-year fixed-rate mortgage surged from 4.1% to 6.7%.

If the federal funds rate hasn’t really been on your radar, have no fear. What follows will help you more fully answer the question: How does the Federal Reserve interest rate affect me? Then, you’ll be on your way to making the best money management decisions for your financial goals, and you’ll have a better understanding of how to profit from falling interest rates (and rising ones).

What happens when the Fed cuts interest rates

One of the Fed’s goals with an interest rate cut is to make borrowing less costly. Translation: You could see lower interest rates on credit, which is good news if you have debt or are shopping for a loan to purchase a home or buy a new car.

Borrowing can become more attractive

John Norris, an economist and podcast host, says a Fed rate cut could be helpful to the average consumer. “If history serves as a guide, the prime rate, or the interest rate lenders charge their most creditworthy customers, will fall by the same amount as the fed funds rate,” he says. “This means credit cards and home equity lines of credit (HELOCs) will be a little cheaper for consumers moving forward.”

In a low-rate environment, you could see lower rates on:

• Credit cards: A Federal Reserve rate cut could translate to a lower minimum payment on credit cards and a lower cost to carry a balance from one month to the next. “Credit card users should always be on the lookout for lower variable rate formulas, and a rate cut or two is a perfect time to do a little homework when looking for new cards,” Norris says.
  
• Mortgages: If the Fed lowers interest rates, homeowners with an adjustable-rate mortgage may experience a rate reduction since the rates for this type of mortgage typically track with the prime rate, which, in turn, is influenced by the federal funds rate. Of course, your interest rate is locked in if you have a fixed-rate mortgage. Prospective homeowners shopping for mortgages may start to see more competitive (i.e., lower) rates available to them.
  
• Home equity lines of credit: If you have a HELOC with a variable interest rate or are in the market for one as you look to save money on home repairs, you could see a rate decrease following a Fed rate cut, which would lower your monthly payments.
  
• Other Loans: For loans, a Fed rate cut could mean lower monthly payments and less interest paid out over the life of the loan. For example, you could see a lower monthly payment if you have a private student loan on a regular payment schedule. Lower borrowing costs can mean more money in your monthly budget to spend, save, or apply to your financial goal of choice.

Chad Rixse, director of financial planning at a wealth management firm, says that when rates are falling, it may be a good time to consider refinancing or consolidating existing debt, such as private student loans, home loans, and car loans. (Refinancing means replacing your existing loan with a new one at a lower rate. Consolidating means paying off multiple loans with a single new loan.)

But it can pay to do your homework. Riley Adams, a certified public accountant and founder of a personal finance website, warns that consumers should be mindful of how much rates have dropped to determine the value of refinancing or consolidating. Using mortgages as an example: “No one should consider refinancing a mortgage after a 25-basis point (0.25%) cut in the rates because the associated costs and fees will probably outweigh any interest savings,” Adams says. “If rates move meaningfully lower, homeowners should be on the lookout for refinancing offers, assuming they have significant time remaining on their mortgage and can benefit from lower interest costs.”

Saving may become less lucrative

As interest rates fall, you may notice your savings accounts aren’t returning as much cash as they used to. That’s part of the give-and-take of interest rate changes. “Banks make money by making a spread between what they pay for deposits and what they charge on loans,” Norris says. “When what they can charge on a loan goes down, it makes sense what they pay on deposits will eventually do so as well.”

To better navigate the ebb and flow of a falling interest-rate environment, you can adopt these strategies:

• Find a competitive savings account rate: Even though savings rates tend to fall when the Fed cuts interest rates, banks could still offer competitive rates. Online banks like Discover^Ò can pass on savings through higher interest rates on their deposit accounts because they save money on the associated costs of owning and operating brick-and-mortar locations. The current rate on Discover’s high-yield savings account is over five times the national savings average.¹
• Lock in a higher fixed rate: If you anticipate more Fed rate cuts in the future, consider savings vehicles with a rate you can lock in. Most Certificate of Deposit (CD) accounts will have fixed rates for their entire term, so if you open a 5-year CD, your savings will continue to earn the same interest regardless of future fed funds rate cuts. (With a variable-rate CD, you’ll typically earn a percentage based on the difference between the interest rates at the beginning and end of your CD’s term.) CDs often come with a penalty if you withdraw funds before the account’s term ends, so they’re best used to hold savings you won’t need to access for that period.

Also, remember that rates are just one factor to consider. Fees for maintenance, specific transactions, and holding a minimum balance can put a dent in your interest earnings. Customer service and online and mobile banking experiences should also be on your list of considerations.

What rising interest rates mean for savers and borrowers

While borrowing gets more expensive when interest rates go up, higher interest rates also mean more attractive savings opportunities. “If interest rates rise, savers benefit by possibly earning more interest on their bank deposits,” says Adams.

If you’re wondering how to profit from rising interest rates, these savings vehicles could earn more interest:

• Savings accounts
• Certificates of Deposit (CDs)
• Money market accounts
• IRA CDs
• IRA savings accounts

You can take advantage of higher savings interest rates and get the most from your savings efforts by increasing the amount of money stashed in your interest-earning savings accounts. The higher the balance, the more you can earn over time.

Choose your term, lock in your rate, and watch your CD grow

Learn more

Discover Bank, Member FDIC

How borrowers can react to rising rates

Despite these increased savings opportunities, a rising-rate environment presents challenges—most notably, borrowing becomes more expensive. Though you can’t do anything to control the Fed’s interest rate changes, you can control how you react. Here are a few ways:

Take the long view

Bill Nelson, advisor and owner of a financial planning firm, believes a long-term plan should account for changes in rates. “Expect interest rates to fluctuate,” he says. He also suggests basing financial plans on your goals, not current events. “Make decisions based on what you’re looking to accomplish with your money,” Nelson says. He explains that your financial goals can help you determine where to save or invest. He tells clients to focus on the timeframe of their financial goal and their appetite for risk. That means the impact of the Fed funds rate is not necessarily part of the decision-making process.

If you’re focused on your goals and what you can control to achieve them—like automating your savings to set aside a specific amount each month ahead of a large purchase—then rate fluctuations may not dramatically impact your plan. Don’t lose sleep over changing interest rates. If you have specific questions about, for example, what the Fed rate hike means for your retirement, then save those for a discussion with a financial advisor.

Delay gratification to maximize gains

Nick True talks about how behavior and habits impact long-term wealth on his personal finance blog. The key? Being disciplined enough to stay on track, he says.

“By letting current rates dictate decisions, you’re chasing short-term wins and instilling overarching bad behavior,” True says.

For example, say you empty your investment accounts (earmarked for long-term wealth building) to buy a home now because you’re worried that rising mortgage rates could increase how much you end up paying for it over time. That nearsighted strategy, however, could have far-reaching costs: You may miss out on the chance to earn returns on your investments. You’ll also reset your savings timeline and may pass up on the power of compound interest, which works best over time.

Don’t panic

If you’re still worried about the ways the Fed interest rate could impact your finances, there are a few additional points to consider:

• Remember that rising interest rates won’t impact your existing fixed-rate loans. Your monthly payments on fixed-rate mortgages, car loans, and student loans will stay the same. If you have variable-rate loans and have noticed an increase in your payments, you may want to talk to your lender about consolidating, refinancing, or changing your loan terms.
• While your Annual Percentage Rate (APR) on credit cards may go up, the specific interest rate you receive if you apply for a new card also depends on factors like your credit score. And if you can pay your balance in full each month, a changing interest rate should have little impact.

How changing interest rates affect overall spending

Aside from borrowing and saving repercussions, the ripple effects of federal funds rate changes will likely extend to your purchasing power and everyday spending.

“By raising the federal interest rate, the Fed makes it more attractive for banks to hold extra capital,” says James McGrath, a housing market expert and licensed real estate broker at a New York real estate firm. “When more money is locked away in vaults, there is less available to make loans and buy things, which slows growth and inflation.”

If inflation is kept to a minimum by the Fed’s benchmark interest rate, prices for everyday items you buy—think groceries or personal care products—have less room to increase. If a Fed rate change stabilizes prices on those items, you can put more money toward savings or paying off high-interest debt. Contrarily, McGrath says the Fed can lower rates to encourage spending. That puts more money into the economy, but it also opens the potential for prices to rise, he says.

Stay informed and stay the course amid falling or rising interest rates

Look at your overall financial situation against the interest-rate backdrop. The list of ways the Fed interest rate may affect you might differ from someone else’s. Ask yourself how you can take advantage of rising or falling rates for maximum financial benefit when it comes to your borrowing, saving, and spending priorities. For example, if you’ve been building a college savings fund for your children and the Fed hikes rates, you may be motivated to put more into savings to take advantage of higher returns. If you’ve been waiting for the right moment to get a loan and the Fed cuts rates, it could be the time to jump in.

Note that the ways the Fed interest rate affects you may also depend on more than just one Fed rate change. “Small changes don’t amount to significant differences over time,” Adams says. “It’s when a long-term rate increase or decrease path becomes the norm that consumers should pay more attention,” he adds.

Above all, remember that rate increases and decreases are a normal part of what the Fed does to keep the U.S. economy working. “Remain calm and carry on,” Rixse suggests. “Don’t let panic or negative emotions guide your decision-making.”

Just like the Fed raises interest rates to help combat nationwide inflation, you have strategies to help your personal financial picture. Learn why inflation can impact your plans for retirement and how to factor rising rates into your savings plans.

Articles may contain information from third parties. The inclusion of such information does not imply an affiliation with the bank or bank sponsorship, endorsement, or verification regarding the third party or information.

This article is for informational purposes only and is not intended as a substitute for professional advice. For specific advice about your unique circumstances, you may wish to consult a qualified professional, at your expense.

¹The APY for the Online Savings Account as of 05/31/2024 is more than five times the national average APY for interest bearing savings accounts with a balance of $500 as reported by Curinos as of 05/31/2024. National average is based on information regarding the top 50 banks (by deposit size) and may not include information from variations in regional pricing at such banks or information from products that may not be widely available to their customers. Rates were obtained from Curinos, who relies on the data from the banks it tracks and such information cannot be guaranteed. APYs are subject to change at any time.