As the Federal Reserve sets its sights on raising interest rates soon, it’s important to keep in mind how this could affect your financial future.
The impact of a quarter-percent interest rate hike on your finances may seem trivial, but it isn’t. Especially if it’s part of a larger trend of rate hikes and coupled with high inflation.
The fact is, if you have debt, you are soon going to be paying more to service it. And, depending on things like your credit score, income, and the amount of your obligations, these expected interest-rate bumps will quickly add up to serious money.
The Federal Reserve (Fed) is our central banking system, and quite simply, it’s arguably the most powerful economic institution in the world. Comprised of 12 regional Federal Reserve Banks that work in tandem (which are responsible for a different region of the United States), the Fed regulates banks and monetary policy. It has just announced that it’s going to start ramping up short-term interest rates beginning this March, which is all intended to help curb the impact of white-hot inflation.
Interest rates play a foundational role in how much it costs to borrow money (including not just how much those monthly payments will be, but what portion of those payments are applied to principal and to interest).
Raising interest rates will increase the cost of borrowing money, which (the thinking goes) will decrease demand, and a decrease in demand should in turn lower prices. (For this discussion, never mind the current supply chain issues.)
There are, of course, other implications. For instance, raising interest rates can also contribute to a decrease in the demand for products (and borrowing), in part because good savers, enticed back into investment alternatives that may now offer better returns, may again be enticed to save more.
Some experts believe that the Fed will increase interest rates up to four times this year. No one knows for certain, but those rate boosts may be 0.25% each time, or they could get aggressive and be as high as 0.5%, or more.
For borrowers – people and businesses that are in debt – who have enjoyed near-record low interest rates for years, these hikes are going to hurt. Let’s assume that the Fed increases interest rates four separate times this year. Let’s also assume that each increase is a quarter of a percent, so that by the end of the year, rates have gone up by 1%.
Now as an example, let’s look at credit cards since these typically come with variable interest rates that follow what the Fed does. Let’s say you have $10,000 in credit-card debt at a 16% APR (and you’re paying $200 a month towards that debt). It will not only take you 83 months to pay off that amount, but you’ll also have to pay about $6,600 in interest.
What if your APR gets boosted by just 1% to 17%? Now it will take an extra five months (88 months) to pay that amount off; and all other things being equal, you’ll have to pay almost an extra $1,000 in interest ($7,500) to do it.
In December alone, inflation rose 7%. That means that the groceries, clothes, and hardware you once purchased for $3,000 have now likely cost you $3,210.
Now, consider that inflation isn’t expected to slow down in the near term. That means that even if that 7% were a high-water mark (and no one is saying it was), some compound increase will likely continue for the foreseeable future. Simply put, you could quickly be spending $300, $400, $500, or more, even much more each month, than you were just a year ago.
Finally, consider the combined costs of both inflation and those higher interest rates on debt. These changes are serious business.
Our experience over the last three decades has been that times like these that are rife with economic policy changes – even changes that may seem small, slow, and insignificant – are the ones that impact personal financial situations the most over time.
Just beware, especially if you have debt, that changes are coming. Get proactive. And if you are in debt, now is the time to talk to your creditors about lowering or keeping your interest rates low.
To get a more precise look at your financial picture – and the potential impact of inflation and rising interest rates – we invite you to speak with one of our airline-specialized advisors. Go to RAA.com/advisor-call to request a complimentary consultation today.