Thursday, December 17, 2015

How the Fed Interest Rate Affects Consumers


On December 16, 2015, the Federal Reserve agreed to increase the federal funds rate (federal reserve interest rate, key interest rate, fed funds rates) by 0.25%  which has remained stagnant for the last 10 years. The federal funds rate is the interest rate that banks and financial institution use to lend money to consumers and applies to those with good credit. The rate affects the entire economy including employment and inflation.

The prime rate is also affected by the federal funds rate. The prime rate is usually equal to or near the federal funds rate. The prime rate is the rate banks lend money to one another and affects the interest rate for mortgages, small business loans and personal loans.

The federal funds interest rate influences stock and bond interest rates, consumer and business spending, inflation, and recessions. It will take several months for consumers to see the impact because it usually takes at least 12 months for the effects of any increase in interest rates to be felt by consumers.

How Interest Rates Affect Consumer Spending

  • Interest is the amount of money that lenders earn when they approve a loan that the borrower repays. The interest rate is the percentage of the loan amount that the lender charges to lend money to a borrower allowing borrowers to access money immediately.
  • An increase in interest rates reduces consumers’ disposable income and consumers must reduce spending on personal goods and services and business goods and services. This will result in a reduction in sales and revenue for businesses. Since the interest rate increase is small it may not have a huge impact on business owners but may affect small business owners who may be struggling to make payroll and accounts payables.

How the Interest Rates Affects Consumers
Overall, the impact will be small for consumers. However, if you owe large amounts of debt you may see an increase in your minimum monthly payment and finance charges. Here are some ways consumers will be impacted:

  • Banks will make fewer loans to consumers and businesses - makes borrowing money harder and more expensive
  • Consumers with variable interest rate credit cards or mortgage loans will pay more in interest
  • Variable student loan interest rates and student loans approved after July 1, 2016 will be impacted
  • Home equity loans, auto loans, variable or ARM Mortgage loans, business and personal loans
  • Earn more money on savings accounts and CDs (certificate of deposit accounts) - open a savings account or contribute more to an existing savings account
  • Money market accounts
  • Retirement accounts - May earn more on your retirement and 401K account
  • Pay more in interest over life of a loan
  • Stock prices may fluctuate, return on investments may decrease
  • Consumers with good credit can still take advantage of lower interest rate offers and perks
How the Interest Rates Affects Inflation
  • The federal funds interest rate affects inflation which is the rise in the price of goods and services over time. When consumer spending starts to decline, the inflation rate will decrease.

How Interest Rates Affect the Stock Market
  • The federal funds interest rate determines how investors invest their money. CD (certificate of deposit), stocks and T-Bonds are affected by rate changes. Stock prices will decrease. When interest rates increase, the demand for lower yield bonds decreases resulting in bond price decrease.

How to Shield Interest Rate Increases
  • Pay down as much debt as possible or totally eliminate debt
  • Refinance existing loans to a lower interest rate or fixed interest rate
  • Exchange variable credit cards for fixed rate credit cards
  • Make large purchases within the next 6 months such as an auto, home, business loan, personal loan

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