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How a Late 2017 Interest Rate Increase Might Impact Your Finances

interest rate impact

Guest Post: By Patty Moore, a blogger who writes about personal finance, careers, and family. You can follow Patty on Twitter @WorkMomLife.

In the United States, interest rates are controlled by the Federal Reserve Bank. It controls a key interest rate, the Fed Funds Rate, that banks charge each other to borrow money. Changes to the Fed Funds Rate ripple through the economy and can directly affect your finances. That’s why so much attention is paid to forecasting any upcoming changes to the Fed Funds Rate.

The Federal Reserve meets six times a year to consider the Fed Funds Rate, and the next meeting is in December. At the most recent meeting, in September, the Fed indicated that it will raise the Fed Funds Rate by one-quarter of 1 percent in December. It bases these decisions on various economic conditions. One is inflation – the general rise in prices across the economy. The Fed fights high inflation, and raising interest rates is an important tool. Note that the Fed anticipates inflation before it actually occurs to get an early jump on the fight against it.

Inflation and Interest

Inflation occurs when the economy overheats and shortages in materials and/or workers develop. Shortages force companies to bid up the amount they’ll pay to workers and suppliers in order to compete with each other. These increases show up in the prices of things you buy, and also in your take-home pay.

Raising interest rates will slow down inflation, because borrowers have to pay more interest when they borrow. That leaves less money left over to pay higher, inflated prices and therefore slows down the economy, which slows down inflation.

So, when the Federal Reserve see signs that the economy is threatening to overheat and raise the inflation rate, it boosts the Federal Funds Rate to slow everything down.

Impact on Borrowers

As we said, a change in the Fed Funds Rate ripples through the economy, because lenders have to pay more interest on the money they borrow in order to lend it out. Therefore, rates will increase on new credit cards, mortgages, car loans, personal loans. If you have borrowed money at a variable interest rate – that is, at a rate that can change over time – then you can expect to pay more interest charges. Most credit cards are variable rate, so a higher Fed Funds Rate should show up shortly on your credit cards’ monthly billing statements. More of your hard-earned money must then go to paying interest on any unpaid balances. You can avoid this effect by paying off your entire balance each month, but that’s often not possible for many of us.

Existing fixed-rate loans, such as those on cars and most mortgages, aren’t affected by changes to the Fed Funds Rate, but new ones will be issued at higher rates. Existing credit cards and adjustable-rate mortgages can see rates change shortly after a Fed rate hike. You can deflect changing interest rates by refinancing variable rate debt (ex. Credit cards) into fixed rate products, see example here. Some experts suggest moving variable rate credit card debt to a fixed rate term loan during rising interest rate environments.

Private student loans frequently charge a variable interest rate. Depending on your student loan agreement, you might see a higher interest rate on your loan right away, or you might not see it for up to a year. Eventually, the higher rate takes hold and your remaining private student loan debt will cost you more money each month. Most student loans in America are made by the federal government and have a fixed interest rate that protects you from rate hikes. However, the Department of Education sets new interest rates each spring that take effect on July 1, causing new loans to be more expensive during inflationary times.

If you have any adjustable rate loans or credit cards, try to replace them with fixed-interest-rate ones when rates are rising. Also, try to pay off your credit cards in full each month, so that you don’t have to pay any interest at all on credit card balances.

Impact on Savers

The flip side of interest rate hikes is that savers earn more interest on their savings. Fed Fund Rate hikes might not impact the amount of interest you earn right away, because banks and other savings institutions use a “sticky” interest strategy. This means that the banks raise interest money on loans right away, but take their time passing along higher interest rates to savers. That’s unfair, but it’s also a fact of life. Eventually, competition causes banks to pay more interest on savings accounts, certificates of deposit and money-market accounts. Investors who buy Treasury bills see interest rates rise quickly on new debt in response to Fed Funds Rate hikes.

Naturally, the effects of a lower Fed Funds Rates are the opposite – good for borrowers, bad for savers. When interest rates are very low, as they had been from 2009 to 2016, it’s hard for some retirees to earn enough interest on relatively safe savings accounts and might turn to riskier sources of income, such as stocks and junk bonds. That’s unfortunate, because retirees are the least able to absorb losses, since they are no longer earning a salary or wages.

Now What:

  • The Federal Reserve is increasing interest rates in 2018.
  • If you currently have variable rate debt (ex. credit cards), plan on your interest rate and monthly payment increasing in 2018. Let this be motivation to pay down debt!
  • Fixed interest rate debt will not be impacted. Consider refinancing variable rate debt to a fixed interest rate.
  • The interest rate you receive on your savings accounts, CD’s, and money-market accounts will increase! This is good news for savers!

About The Author

Patty Moore is a single mother to one beautiful daughter while working 40 hours a week. She writes about parenting, family finances, and creating a work life balance in her blog Working Mother Life. Her hope is to help other women in similar situations to hers become better and more balanced mothers.

 

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“Safe” Investments: What You Need To Know

The 8th Wonder of The World.

ae-quotes
Albert knows his stuff

Money is pretty cool right? And knowing that compound interest is the 8th wonder of the world, (Thanks Einstein for that gem) we usually turn to dropping our money in the bank.

Problem is, that money makes next to zero doll-air-oes. Back in the 90’s when interest rates with in the 12-14% it was safe to put money in a CD at 10% interest. Today, interest on a 3-year CD is puny, 1.4%. Interest rates are down 90%, which is good for inflation and other things, but makes me think, “What do I do to grow my money?

Numbers

First: let’s talk numbers. I conducted a survey and found that most people struggle with knowing where their money can grow, and what’s riskier or not.

Problem: “What tends to have the highest growth over periods of time as long as 18 years”

A. Checking Account
B. U.S. government savings bonds
C. Stocks
D. Savings Account

What is your answer?

I’m glad to say that not a single person put Checking Account. I’ll still explain that for a moment, a Checking account is what I classify as “Cash & Cash equivalents”. It’s liquid, it’s being used day-to-day, and mine currently has a return of .02%. This isn’t where money goes to grow, it’s where a money goes to be spent.

B. U.S. government savings bonds. These investments are usually given a pretty small interest rate, and are guaranteed by the government. I was actually quite shocked by just how many people thought that this was the best place to grow money! These are given a guaranteed return, but usually is equal or less than what inflation is.

D. Savings account. A few people thought this was a good place to grow money. Savings accounts are similar to Checking Accounts, in the fact that they have very poor growth rates, usually higher than Checking, but still very low. In my mind, they are basically a way to keep your money in 2 seperate locations so you don’t spend it all. I think there are better ways to organize money, but that’s just my thoughts.

C. The Stock Market. This is where money goes to grow. Naturally there are risks, but there are many ways to mitigate the risk. Diversification, Allocation, and having a good time horizon for investments helps. With an 18 year time frame, and being diversified across many stock types, this is where money will grow.

Lets look at the data

I looked into typical rates for Savings Accounts, Checking Accounts, Government Bonds, Corporate Bonds, and the Average Stock Market Yield. Here is what $1000 dollars looks like over a 20 year investment.

growthof1k
Chart by TheFinancialGinger – 2016
www.nerdwallet.com/rates/checking-account – Zion’s Bank Checking Account
www.nerdwallet.com/rates/savings-account -Zions Bank Savings Account
www.treasury.gov/resource-center/ – Government Bonds
finance.yahoo.com/bonds/composite_bond_rates – 20 year AA corporate bonds
http://www.moneychimp.com/features/market_cagr.htm – Stocks average from 1995-2015

Looking at this, some people are probably shocked. Know that Stocks have the risk of going down, they will go down and up. Greater Risk often yields greater upside potential.

Fine, I’ll put it in stocks. How do I do that?

If you have $5000 or $10,000 to invest, put it into the stock market. There are some great places to open an account online.

TDAmeritrade has a pleasant platform that is excellent for beginners and isn’t too expensive to use at $10 per trade.

OptionsHouse is an online broker that has $5 trades and has no minimum balance.

TradeKing is another online broker that has $5 trades and no minimum balance.

My absolute personal favorite is Vanguard. The reason for that is they are all about the idea of buy-n-hold with stocks, and stock-packages called Mutual Funds or ETF’s. The idea behind that is simply buying a preset group, then waiting and letting it grow over time.

If not, you can probably talk with your Bank, Credit Union, or find a good local individual company such as EdwardJones to get you started. Make sure that if you use a broker/dealer company that you know the cost associated with it.

In Summary

Checking accounts are where money goes to be spent. Savings accounts are for emergency funds and money to be used within 6-12 months. Bonds are where money grows safe but small, and the stock market is where money belongs for long-term growth.

So, open an investment account and invest! Don’t let $5000 extra dollars be left sitting for no reason in the bank.