What does the fed interest rate mean

The Federal Reserve (Fed) just raised interest rates by 0.75%. Compared to recent Fed rate changes, this is quite a large increase, so let’s look at a few commonly asked questions.

FAQs

What rate did the Fed increase?

It’s important to realize that the Fed does not control all the interest rates in the economy. Instead, it has control over something called the “Federal Funds Target Rate”. This rate is what banks pay and receive when they borrow and lend excess funds to each other overnight. But this short-term interest rate impacts a range of other rates in the economy including savings rates, credit card and car loan rates, as well as mortgages.

So why did the Fed raise interest rates?

The Fed increased the Target Rate in order to combat inflation which is currently running at more than 9%. The Fed hopes that by raising the cost of borrowing, consumers and businesses will be less likely to take out loans to purchase stuff. For example, higher interest rates will make the cost of financing a car, or a new home more expensive. This increase in borrowing costs will, in turn, lead to a lower demand for stuff, which it is hoped will reduce the upward pressure on prices resulting in lower inflation.

Is there any downside to the Fed’s action?

The risk of raising interest rates is that if the Fed increases them too suddenly, the drop in consumer and business demand could push the economy into a recession. It’s a balancing act of tapping the brakes on the economy without bringing it to a screeching halt.

How will this affect consumers?

For consumers, the Fed interest rate hike will likely have a range of impacts. If you are planning to finance a major purchase (a house or car for example), your payments could end up being higher.  Also if you are carrying variable rate debt, such as credit card balances, you may also see higher interest costs.   

There are some positives. If you have savings, you may see a small increase in the interest rate paid on your money. But, probably the biggest potential benefit is that if the Fed is successful in bringing down inflation, then we should see prices of things we buy increase much more slowly than we’ve seen recently.

What about financial markets?

For the financial markets, the Fed rate increase is generally considered a good thing.  Stock prices increased on the announcement, as investors view taming inflation a good thing for companies and the economy. Although in the short term, higher interest rates can increase costs for businesses, this is likely preferred to an all out recession. Interestingly, US long-term Treasury Yields (the rate at which the Government borrows money) declined. This decline is slightly counterintuitive, but is consistent with the bond market anticipating lower inflation in the future.

What should consumers do?

If you can avoid borrowing, or delay borrowing, you may get more favorable rates in the future, but for many people that’s not an option. Regardless of the Fed action though, you should always pay your highest interest rate debt first if you have a choice. For long-term investors, the general advice is more straightforward; maintain a diversified portfolio, and ride out these short-term gyrations in the market.

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LendingTree is compensated by companies on this site and this compensation may impact how and where offers appears on this site (such as the order). LendingTree does not include all lenders, savings products, or loan options available in the marketplace.

Written by

Jessica Sain-Baird

Alex Cook

Edited by

Ismat Mangla

Ken Tumin

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been reviewed, commissioned or otherwise endorsed by any of our network partners.

The Federal Reserve raised the benchmark federal funds rate today, this time by 50 basis points to a new target range of 4.25% to 4.50%. This was the seventh straight meeting in which the U.S. central bank raised rates to fight sky-high inflation, which has been running hot throughout 2022. Many anticipate further rate increases into 2023.

Why does the Fed raise interest rates?

The Fed hopes that by raising interest rates — which makes it more expensive for consumers and businesses to borrow money — it can decrease demand and restore price stability.

Tightening monetary policy by increasing rates runs the risk of causing a recession and hurting a strong job market, but the Fed has argued that the risks of sustained inflation are more serious. Inflation has reached its highest level since the 1980s. Back then, the Fed responded forcefully with significant rate increases, which plunged the economy into a recession — but brought prices under control.

At the start of the COVID-19 pandemic, the Fed slashed rates to zero as part of a broader fiscal and monetary stimulus strategy to prevent long-term economic damage. The plan worked, as the U.S. avoided the worst-case scenario. The job market quickly recovered, households were able to save money and an effective vaccine helped bring life back to normal.

However, an imbalance between low supply and high demand has created upward pressure on prices across the economy. The pandemic, as well as Russia’s invasion of Ukraine, has impacted shipping, labor, energy and commodities markets. Meanwhile, there’s been more competition among consumers to purchase goods and services and more competition among businesses to hire and retain workers.

Together, those dynamics have caused prices to rise significantly, according to Consumer Price Index (CPI) data. Raising interest rates will decrease demand and hopefully cause prices to fall, but a probable recession looms over the horizon.

What to do when interest rates rise

So what does a Fed rate hike mean for you?

“Expect to pay more on the interest charges from your credit card company, and auto loans and mortgages will also become more expensive,” says Ken Tumin, LendingTree’s senior banking industry analyst. “On the flip side, we can generally expect banks to raise their savings account rates when the Fed increases its benchmark rate.”

Here’s how to prepare for rising interest rates.

Pay down your credit cards

Your credit card interest rate is likely to go up within a month or two of this news. If you’re carrying credit card debt, this means your monthly payments will grow and you’ll be paying more in interest — costing you a lot more money. 

If you currently have credit card debt, consider making bigger and more frequent payments to pay it off more aggressively. Signing up for a 0% interest balance transfer credit card or getting a debt consolidation loan could be another option to protect you from paying more interest, at least in the short-term. Looking to open a new card altogether? A card with an intro 0% annual percentage rate (APR) offer can shield you from fluctuating interest rates for a while. 

Lock in your mortgage rate

Mortgage rates are at their highest in over 20 years. But if you already have a fixed-rate mortgage, don’t worry — your interest rate will stay the same. 

Costs for aspiring homeowners may increase, though. “Mortgage rates could trend up over the next few weeks,” says Jacob Channel, senior economic analyst for LendingTree, but “there’s no guarantee that mortgage rates will change all that drastically. Remember that while the Fed’s actions do impact mortgage rates, it doesn’t directly set them. With that said, rates on products like home equity lines of credit (HELOCs) and adjustable-rate mortgages (ARMs), which are pegged to the prime rate, will increase.”

If you’re looking to buy a home or refinance a mortgage, don’t stress about rates. “While mortgage rates are important, obsessing over them too much is liable to do more harm than good,” Jacob says. “If you’re in a place right now where you can afford to buy a home without becoming excessively cost burdened, then you shouldn’t worry too much about whether or not rates could eventually come down.”

Set your auto loan rate

Like mortgage rates, auto loan rates can go up with Fed rate hikes while lenders adjust to the new federal funds rate. Refinancing terms also become less favorable in an environment of rising rates. Locking in a lower rate now may help ensure you’re spending less money on interest and getting the best value on your car purchase.

If you’re planning on buying a new or used car, pay attention to the APR and move fast if you want today’s rates. With the federal funds rate continuing to rise, the interest rates on new auto loans could rise as well.

Grow your savings

There’s some good news when it comes to the Fed raising interest rates: savings and other deposits earn more interest. “Deposit rates are reaching highs not seen in more than a decade,” says Ken. “Further deposit rate increases are likely as the Fed continues to hike rates.”

But be sure to shop around for the best rates, because not all banks will pay you more. “Many banks have been slow with rate increases as their deposit levels have remained high,” says Ken. “To benefit from the higher interest rates, you may have to move your money to those banks which are willing to pay higher savings account rates.”

Look for a high-yield savings account — online banks will probably be your best bet — to ensure you’re getting a competitive rate. You may also find a certificate of deposit (CD) or an I bond to be a good option when it comes to protecting the value of your long-term savings. They have higher rates, but you’ll need to sacrifice some short-term liquidity.

Prepare for student loan repayment

The Supreme Court will hear challenges to President Biden’s student loan forgiveness program in 2023, so the U.S. Department of Education has extended the federal student loan payment pause again. Payments will resume 60 days after the program is permitted to begin or litigation is resolved. If neither has happened by June 30, 2023, then payments will resume 60 days after that date.

“If it’s been a while since you’ve made a federal student loan payment, you might want to log into your account at studentaid.gov and check how much you still owe, after any forgiveness you might qualify for,” says Michael Kitchen, student loan managing editor at LendingTree. “If you think you’ll have difficulty keeping up with repayment when it restarts, talk to your servicer about your options — especially income-driven repayment plans.”

Rising interest rates won’t impact existing federal loans, which have fixed interest rates, but could make future student loans more expensive. If you have fixed-rate private loans, those rates won’t change either, but the rate on variable-rate loans will very likely rise. Student loan refinancing may become less common as interest rates rise, but the terms for private, refinanced loans could become less favorable moving forward due to rising rates.

What’s next for the Fed and the economy

The path of future Fed rate hikes depends on whether progress has been made in bringing inflation down. The Fed considers a wide range of economic data points, including CPI and Personal Consumption Expenditure (PCE) inflation, as well as more specific price data. Unless the Fed sees evidence that price increases are subsiding in a meaningful way, the Fed will probably keep raising rates.

In recent meetings, Chairman Jerome Powell has acknowledged that raising rates will cause an increase in unemployment. It’s likely that millions of Americans will lose their jobs during this tightening cycle as the demand for workers decreases and a strong labor market weakens. Powell has argued that labor market strength cannot exist in the long run without price stability, so the Fed is willing to tolerate that pain in its effort to slow down inflation.

Frequently asked questions

How does raising interest rates help inflation?

The Fed raises interest rates to slow the amount of money circulating through the economy and drive down aggregate demand. With higher interest rates, there will be lower demand for goods and services, and the prices for those goods and services should fall.

Did the Fed raise interest rates?

Yes, the Fed raised the federal funds rate at its last meeting in December. While the Fed doesn’t directly control the rates at which banks lend to consumers and businesses, the federal funds rate, which determines the rate at which depository institutions lend each other money, affects those rates.

When is the next Fed rate hike?

The Fed could raise interest rates again at its next meeting, which is scheduled for January 31-February 1. Until the Fed sees price indexes start to show inflation falling significantly, rate hikes will continue, and the federal funds rate will remain elevated.

What happens when the Feds raise interest rates?

How does the Fed interest rate affect the economy?

What does Fed rate increase mean?

Why is the Fed raising interest rates?