What the Fed's interest rate hike means for you & how to soften the blow

Higher interest rates typically dissuade consumers from borrowing and spending.

Tanza Loudenback

By 

Tanza Loudenback, CFP®

Tanza Loudenback, CFP®

Contributing Reporter & Certified Financial Planner™

Tanza Loudenback, CFP® is a contributing reporter and Certified Financial Planner™ at Policygenius, where she covers personal finance and insurance news. Previously, she was a senior reporter and correspondent at Business Insider.

Published May 11, 2022 | 3 min read

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The Federal Reserve on May 4 approved its biggest interest rate increase in more than two decades. The half-point hike is part of an effort to beat back rapid inflation, in which the prices of everything from groceries to utility bills have skyrocketed.

Typically, higher interest rates dissuade consumers from borrowing (and therefore, spending). As demand for big-ticket items like houses and cars wanes, prices tend to stabilize. 

“As a saver, you'll likely respond differently than a credit card user when interest rates rise,” says Lyle Solomon, a principal attorney specializing in consumer finance at Oak View Law Group. “When the Fed raises rates, savers benefit, but they suffer when the Fed lowers them.”

The reality is that most people save, borrow, and invest simultaneously. Below, we explore what the Fed’s latest move means for each aspect of your finances.

Saving will yield higher returns

Expect the interest rate on savings accounts and certificates of deposit to improve in the coming months.

“Depending on the bank's location, you'll notice greater (annual percentage yields) on deposits sooner or later,” Solomon says. “Online banks, local banks, and credit unions often provide greater yields than larger banks, and they may raise rates more quickly since they contend for deposits more fiercely.”

To be sure, savings rates won’t come close to matching current inflation rates. You’re still going to come up short whether you store your money in a savings account or a CD. But a savings account is still a good choice for having ready access to your funds, despite the potentially greater returns of the stock market.

Borrowing will get more expensive

Consumer loans that charge variable interest rates — credit cards, home equity lines of credit, or personal loans, for example — will get more expensive for borrowers almost instantly, Solomon says. 

If you’re paying off a credit card balance or financing a purchase with a variable APY, expect your monthly payment to increase. If you can, Solomon says, transfer your balance to a credit card with a 0% APY offer and pay off your balance before the offer term is up. 

“In the case of student loans,” Solomon says, “certain private loans are linked to Fed rates, so there's a chance that interest rates will climb. It is a good time to double check that you understand your loans and try refinancing them before interest rates rise more.”

As for mortgages, the federal funds rate doesn’t directly impact the interest rate charged by lenders. Still, the Fed’s overall strategy for slowing demand — known as tight monetary policy — has a domino effect on other aspects of the economy, including the housing market. 

Mortgage rates began rising in anticipation of the Fed’s May 4 rate hike and are expected to continue throughout the year. The result may be that homebuying becomes more unaffordable, but competition cools.

Investors: Don’t make sudden moves

It hasn’t been a smooth spring for the stock market. Investors have feared that the Fed would enact a too-tight monetary policy, halting consumer demand after nearly two years of encouraging it. But the latest interest rate increase was relatively modest, and there’s little (if any) reason for individual investors to panic and sell.

“The stock market reacts to Fed rate hikes in a muddled manner,” Solomon says. “On the one hand, higher rates may encourage confident investors to grab profits and liquidate their equities. However, there is ample proof that rate hikes do not harm stocks in the long run.”

If you’re a long-term investor with a diversified portfolio, stay the course. Short-term market volatility is the price you pay for long-term growth

What next?

It’s an ideal time to review your personal balance sheet and re-evaluate your spending habits. As the Fed tightens its purse strings, the cost of making purchases with borrowed funds will increase. That’s a tough pill to swallow for consumers who are accustomed to using credit cards and loans as a stopgap. But it’s also a necessary step to tamping down inflation..

“In a rising-rate market,” Solomon says, “improving your credit score, clearing off high-cost debt, or refinancing (current debt) at a cheaper rate can help you build more available funds.”

Image: shunli zhao / Getty Images