Should you be worried about interest rates going up? It's complicated

Many interest rates are based on the federal funds rate, so you can expect the Fed’s actions to reverberate throughout your financial life.

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The Federal Reserve will likely raise interest rates in 2022 in response to rising inflation.

A majority of the members of the Fed’s Open Market Committee, which sets monetary policy for the country, say they expect the federal funds rate to rise to 0.875% this year, after sitting at close to 0 since the onset of the COVID-19 pandemic.

Many interest rates are based on the federal funds rate, so you can expect the Fed’s actions to reverberate throughout your financial life. Here’s how higher interest rates will affect you.

1. Variable rate loans

Higher interest rates are good for savers and bad for borrowers. Variable-rate loans like credit cards and home equity lines of credit follow the federal funds rate closely, so you can expect to face higher costs on these loans quickly if the Fed raises rates.

“I would recommend paying down these types of debt before rates start increasing,” says Chris Diodato, certified financial planner and founder of Wellth Financial Planning.

→ Read our list of 50 ways to pay off debt.

2. Savings yields

On the other hand, higher interest rates will be good for savers. If you’ve been disappointed with your so-called high-yield savings account, you can expect a higher return from your savings after years of anemic interest rates.

Financial products like bonds and the cash value component of a whole life insurance policy will also see higher returns as rates rise.

3. Mortgages

The federal funds rate also impacts long-term loans like mortgages, though the housing market and overall economy also affect mortgage rates. These rates have started to creep up over the past year, and they should continue to rise along with other interest rates in 2022.

Does that mean you need to rush to buy a house before rates climb further? Ryan Sterling, certified financial planner and founder of Future You Wealth cautioned against this.

“One thing that very well could happen is yes, while rates may make your payment go up, what you should also potentially see is prices come down,” Sterling says.

Plus, he adds, while mortgage rates are climbing, they are still historically low, even compared to their 2018 peak. 

4. Inflation

One of the Federal Reserve’s responsibilities is to keep prices stable. It raises interest rates to control inflation.

The Consumer Price Index, a federal measure of inflation, has increased almost 7% year over year, which means you’re paying higher prices for things like cars and groceries. When the Fed raises interest rates, it makes borrowing to buy things more expensive, which lowers demand for products, which should (if you are wearing your macroeconomics 101 hat), lower prices.

In practice, this is a delicate balancing act.

“The Federal Reserve needs to take special care to raise rates enough to calm down inflation, but not so much that it shrinks overall demand so much that it causes an economic slowdown,” Diodato says.

5. Investments

Low interest rates have helped fuel some of the weird personal finance developments of recent years. They’ve led investors to seek higher yields in some strange places, like meme stocks and cryptocurrencies. 

With higher rates constraining the amount of money investors can borrow, Sterling believes we could see a return to more normal, boring investing strategies.

“As the Federal Reserve takes away that stimulus, I think that’s going to be a headwind for markets, but I think the tailwind is that solid companies, for the most part, are in really good shape,” Sterling says.

Sterling doesn’t expect to deviate much from the investing strategies he’s already created for his clients, even if the market’s initial reaction to rate increases is negative. 

“If you have a plan in place, the Federal Reserve going through three to four interest rate increases next year should not have a material impact on your plan,” Sterling says.

Image: Andrew Bret Wallis / Getty