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Much as economic analysts had expected, the Federal Reserve announced that it was raising the target federal funds rate by a quarter of a percentage point to between 1.75% and 2%, and indicated it expects to make more rate hikes in 2018.
The federal funds rate is a benchmark interest rate that determines how much it costs for financial institutions to lend to one another. When the rate rises, so does the cost of borrowing for banks. They may in turn pass their higher costs to consumers in the form of increased interest rates on credit cards, auto loans, mortgages and other types of financial products.
So why would the Fed raise rates? In a nutshell, it means that the country’s central bank believes the economy is strengthening. When times are tougher, the Fed lowers the rate in order to make it easier for consumers and businesses to borrow and spend, thus pumping more money into the economy (which is why the Fed kept rates near zero during the recession). But when the economy shows improvement, the Fed may choose to raise rates in order to keep inflation in check.
There’s a lot more economic theory involved in understanding the impact of Fed rate hikes, but what you’re probably most interested in is the effect on your personal finances. If you’re concerned about what the Fed’s announcement could mean for you, here are a couple things to keep in mind.
Interest rates are still low, relatively speaking
Remember that even with a rate hike, interest rates are still historically very low. Case in point: Back in December 2006, before the height of the recession, the federal funds rate was above 5%. Back in the mid-to-late 80s, it hovered closer to 10% and in the early 80s, it was in the teens.
Some interest rates have already been creeping up
Talk of the Fed raising rates isn’t new news, so you may have already felt some effects without realizing it. “This interest rate hike has been widely expected, so most consumer interest rates have already climbed in anticipation,” says financial planner Matt Shapiro, CFP®.
So you probably won’t experience some immediate sharp spike based on the Fed announcement; in reality, you may have been dealing with it already within your budget. Plus, any loans for which you previously locked in a fixed rate won't be affected by the Fed announcement. But if you are concerned about how the rate hike could affect your loans or credit cards, keep tabs on any interest-rate changes from your lenders to see if you need to make adjustments to your debt payoff plans or monthly payments.
Also, remember that an interest rate hike isn’t always about paying more. You may notice a slight increase in interest you earn on savings, certificates of deposit, money-market accounts and other types of financial accounts as a result of the Fed decision.
Strong credit is still key to keeping your borrowing interest rates low
Yes, you might see an uptick in your credit card annual percentage rate or other loans with variable interest rates, but having a strong credit score is still the larger determinant of what type of interest rate you might pay, according to Shapiro. “For credit card debt, I would be more concerned with credit scores than with the Fed,” he says. “An individual's credit score has a much larger impact on their interest rate.”
So focus instead (as you may already have been) on keeping your credit healthy by making on-time payments and keeping your total debt low.
Market turbulence will come and go, so stick to your investing goals
It’s almost a given that the markets will respond with some volatility to a major economic announcement. But don’t let that cause knee-jerk reactions on your part; any portfolio moves you make should still reflect the goals you have for your investments, your timeline to those goals and your risk tolerance, Shapiro says. If it’s time to check in on your portfolio in order to rebalance, then go ahead and do so — but keeping a constant watch simply in response to market news will only add to the stress.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.