Your first credit card or student loan payment probably gave you a crash course in how interest rates work and that lesson has influenced nearly every financial decision you’ve made since. These percentages determine how your investments grow, how much you’ll pay toward your mortgage and whether you qualify for an auto loan.
While you might recognize that interest rates reflect broader market conditions, such as employment trends, global conflicts or the availability of natural resources, the reasons behind their fluctuations can seem complex. Learn why rates rise and fall, and what those changes mean for borrowing and saving.
How Do Interest Rates Work?
Interest rates don’t move at random; they’re monitored and adjusted by the Federal Reserve. The Federal Reserve views interest rates as a measure of economic growth and stability: changes in these percentages influence inflation, unemployment and Gross Domestic Product (GDP).
When the economy grows too quickly or inflation rises, the Federal Reserve may increase rates to encourage saving and slow down spending. Conversely, when growth stalls, it may lower rates to make borrowing more attractive and help stimulate consumer spending.
Once the Federal Reserve makes adjustments, banks respond – translating national policy into the lending and savings rates consumers see every day. Your bank considers the Fed’s direction, economic conditions and credit demands to establish its own product-specific rates, which often exceed federal benchmarks.
How Changing Interest Rates Impact Your Finances
When rates shift, this also impacts your personal finances. Here’s what happens in different scenarios:
- When Rates Rise: For variable-rate products like credit cards and certain loans, your monthly payment will go up – sometimes noticeably. Qualifying for new loans may also become more difficult, as lenders raise their approval standards.
- When Rates Fall: Borrowing becomes easier. Mortgages, credit cards and home equity lines of credit (HELOCs) may carry lower interest, reducing your payments and total loan cost. You might even pay off debts faster! Â
- Purchasing Power: Major purchases are best made during low-interest periods. It’s easier to lock in a favorable rate that lasts for the life of the loan. If you have an older mortgage with a higher rate, refinancing could reduce your monthly payment.
How Interest Rates Affect Lending and Loan Payments
Interest rate changes are especially visible in the housing market. Higher rates often mean larger monthly payments and greater total loan costs, discouraging or disqualifying potential buyers.
Meanwhile, those with adjustable rate mortgages (ARMs) can see payments fluctuate dramatically within months. Here’s how rate shifts influence different aspects of borrowing:
- Obtaining Credit: When rates rise, lenders often reserve loans for borrowers with strong profiles – higher credit scores, longer histories and lower debt-to-income ratios. Those with lower credit may face smaller loan amounts or tighter conditions. However, lower rates open more options for all borrowers.
- Types of Debt: Rate differences matter most for long-term loans. A higher rate might add little to a short-term auto loan but could cost tens of thousands more on a 30-year mortgage.
- Variable Rates: With products like credit cards or HELOCs, payments can increase from month to month. Building a budget cushion can help manage these changes.
- Secured vs. Unsecured Rates: Secured loans like mortgages and auto loans typically change more predictably, mirroring Federal Reserve shifts. Unsecured loans like credit cards can experience sharper rate jumps, which impact your monthly payments more directly.
How Interest Rates Affect Savings Accounts and Deposits
When interest rates rise, savers benefit but when they drop, returns slow down.
- Interest Rate Changes: Higher yields lead to faster growth for savings, money market accounts and certificates of deposit. Lower rates mean slower appreciation, as banks pay less to maintain these products.
- Real Value: Even if your savings grow at five percent, inflation can lower your gains. For example, if inflation increases by two percent, your true spending power rises only by three percent.
When to Consult a Financial Professional
If you’re wondering whether it’s a good time to invest, open a savings account or apply for a loan, an experienced financial professional at Ion Bank can help you understand how interest rate changes affect your specific situation. Contact us today to learn more.