How does the Federal Reserve interest rate affect me?

You may not realize it, but behind the scenes the Federal Reserve is quietly influencing your everyday life when it comes to borrowing, saving, and even spending. Serving as the central bank of the United States, the Federal Reserve, or Fed, is responsible for managing the country’s monetary policy. A big part of its job is adjusting the federal interest rate. Also known as the federal interest rate, it’s the short-term interest rate banks charge each other to lend funds overnight. The Fed decides whether or not to raise or lower this benchmark interest rate in order to reach maximum employment and stable inflation.

The Federal Reserve raises and lowers rates in response to fluctuating economic conditions.  Typically, the Fed prefers to make gradual rate changes so that any ripple effects are minimal. However, major shocks to the economy from events such as the global pandemic or soaring inflation can lead to more aggressive action. 

For instance, 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 raised rates several times. In mid-March 2022, the federal funds rate was 0.25-0.50%, but by the end of July federal funds rates had already increased to 2.25-2.50%.

OK, wait. Policymakers, the economics behind employment and inflation, overnight lending between banks… so how does a change in interest rate affect your decision to spend or save, you ask? To borrow from a popular saying: “So goes the federal funds rate, so goes consumer interest rates,” says Riley Adams, a certified public accountant and founder of a personal finance website. Whether rates are going up or down, a change to the federal interest rate could have a ripple effect in the same direction on everything from interest rates on CDs to interest rates on mortgages that affect borrowers, savers, and spenders.

If this is news to you and the federal interest 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 rising interest rates, as well as falling ones.

How rising rates can benefit savers

In an interest rate environment like 2022, many people tend to ask, “How does the Federal Reserve interest rate affect me when rates go up?” In a higher interest rate environment, your savings may actually be able to get a little more love.

“If interest rates rise, this benefits savers by possibly earning more interest on their bank deposits, assuming their bank indexes interest rates on deposits to remain competitive against other banks,” Adams says.

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

• 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 will earn.

Yes, borrowing gets more expensive with rising interest rates. But the positive side to a higher interest rate environment is that rising interest rates can encourage you to save more to capitalize on the greater returns.

How you can react to rising rates

While there’s nothing you can do to control the Federal Reserve’s rate changes, you can control how you react to rising rates. 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 up and down,” he says. He also suggests making your financial plans about 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 you should save or invest. The factors he tells his clients to focus on? The timeframe of the financial goal and your personal appetite for risk. That means questioning the ways the Fed interest rate could impact your finances 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 fluctuations in rates may not dramatically impact your plan. Don’t let changing interest rates keep you up at night. If you do 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 likes to talk about how behavior and habits impact long-term wealth on his personal finance blog. Being disciplined enough to stay on track, he says, is key.

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

Say, for example, you empty your investment accounts (which you’ve earmarked for long-term wealth building) to buy a home now because you’re concerned about how rising interest rates will impact your finances. You may get the short-term win: becoming a homeowner sooner rather than later and before mortgage rates may have the chance to rise.

But that immediate “win” could come at a long-term cost: missing out on the chance to earn returns on your investments. You’ll also reset your savings timeline and may miss out on the power of compound interest, which works best over time.

Don’t panic about rising interest rates

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

• Again, rising interest rates won’t impact fixed-rate loans that you already have. Your monthly payments on fixed-rate mortgages, car loans, and student loans will remain the same.
• You may want to think about consolidating or refinancing from variable-rate loans to a fixed-rate loan if you’ve already noticed your payment go up.
• APRs on credit cards may go up, but the specific interest rate you receive if you apply for a new card also depends on your own credit score.

How a low interest rate environment makes borrowing more attractive

The answer to, “How does the Federal Reserve interest rate affect me?” can be a positive one in a low-rate environment if you have debt or are looking for new borrowing opportunities. When the Fed cuts rates, borrowing money tends to become less expensive since banks and lenders also typically lower rates on their credit products.

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

• Credit cards
• Auto loans
• Personal loans
• Private student loans
• Home equity lines of credit
• Adjustable-rate mortgages
• Business loans

Why the federal interest rate matters for consumers and the credit cards in your wallet has to do with minimum payments and interest charges. 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. When it comes to the relationship between a Fed rate cut and a savings account, interest rates will often fall for those accounts, too. For loans, a Fed rate cut could mean lower monthly payments and less interest paid out over the life of the loan. Lower borrowing costs can add money back to your budget that you could use to spend, save, or apply to your financial goal of choice.

If you’re wondering how the Federal Reserve affects mortgage rates, there’s good news there, too. When the Fed lowers rates, homeowners with an adjustable-rate mortgage and homebuyers shopping for one may experience a rate reduction, since the rates for this type of mortgage typically track with the prime rate, which is in turn influenced by the federal interest rate. The lower your mortgage rate, the lower your monthly payment and the more home you might be able to afford. Keep in mind that fixed-rate mortgages are less directly impacted by a Fed rate cut.

Chad Rixse, director of financial planning at a wealth planning 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.)

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When answering, “How does the Federal Reserve interest rate affect me?” for yourself, Adams adds that consumers should be mindful of how much rates have dropped to determine the value of refinancing or consolidating. Using mortgages as an example: “They should not consider refinancing a mortgage after a 25-basis point (0.25%) cut in the rates because the associated costs and fees will outweigh any interest savings,” Adams says. “If rates move meaningfully lower (1.00%+), they should be on the lookout for refinancing offers, assuming they have significant time remaining on their mortgage and can benefit from lower interest costs.”

How changing interest rates can affect spending habits

The ripple effects of the federal interest rate even 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-based 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 things you buy every day—think groceries or personal care items—have less room to increase. If a Fed rate change keeps those everyday prices low, you can put more of your money toward savings or paying off high-interest debt.

On the flip side, McGrath says the Fed can lower rates to spur spending. That puts more money into the economy, but it does open up the potential for prices to rise, he says. Higher prices could mean that your money has to stretch further to buy the same things, especially on big-ticket items like a college education or a mortgage.

How the Fed can influence federal mortgage interest rates

It can be tricky to figure out what assets do well with rising interest rates and what assets do better with falling rates. When it comes to understanding how interest rates affect mortgage rates, you might experience even more confusion. The Federal Reserve doesn’t set mortgage rates, but it does indirectly influence them. When the federal interest rate is rising, you’ll often see mortgage interest rates rising, too. In 2022, the federal mortgage interest rates are higher than they were in 2020, because the Fed raised rates and federal mortgage rates reflect that trend.

Keep in mind that the fluctuations in interest rates only affect those with adjustable-rate mortgages and those who are currently shopping around for a mortgage. If you already own your home and entered into a fixed-rate mortgage, your interest rate is locked in.

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

Look at your overall financial situation against the backdrop of what’s happening with rates. Your list of ways the Fed interest rate affects you might be different than 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 the Fed hikes rates and you’ve been building up a college savings fund for your children, you may be motivated to put more into savings to take advantage of higher returns. If rates are cut and you’ve been in the market for a loan for some time, now could be the time to jump on it.

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. “Remain calm and carry on,” Rixse suggests. “Don’t let panic or negative emotions guide your decision-making.”

In 2022, the Fed began aggressively raising rates to combat inflation. Learn more about inflation and its effects on your savings, plus how to protect your savings when prices rise.

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