Understanding the Impact of the Federal Funds Rate Increase on Your Finances

Updated on January 23, 2023

Stay informed on the latest federal funds rate increase and learn how it can affect your finances. Discover how to take advantage of the increase through high-yield savings accounts, and learn how to navigate high inflation with alternative options. Understand the impact of the federal funds rate on borrowers and savers with this informative guide.

Summary

On Dec. 14, Federal Reserve officials raised the federal funds rate by half a percentage point, making it the seventh increase this year.
Despite the smaller increase, it may still have an impact as higher interest rates can lead to higher costs for borrowers but also higher yields for savers.
The federal funds rate, also known as the “Fed rate,” is the interest rate at which banks lend money to each other overnight.
The Federal Reserve sets the rate to help implement monetary policy based on economic conditions.
Consumers may be affected by a federal funds rate increase by raising the cost of loans or credit cards, which may result in households borrowing less, leading to lower spending and potentially lower inflation.
When the Federal Reserve raises interest rates, it’s a good opportunity to review your savings account options and compare rates.
Online savings accounts often offer higher rates due to lower overhead costs, such as not having to operate physical branches.
With high inflation, it may seem that putting money in a savings account is not beneficial as it erodes the purchasing power of your money.
However, having a savings account is important for having quick access to funds in case of unexpected expenses and helps prevent going into debt.
It is recommended to have at least 3-6 months’ worth of expenses saved in an emergency fund, but any amount saved can help.
When a savings account may not be beneficial, other short-term options can be considered such as inflation-matching savings bonds or certificates of deposit that have higher yields than traditional savings accounts but require you to leave the money parked for a certain period of time.

Federal Funds Rate Increase: What It Means for Borrowers and Savers

On Dec. 14, Federal Reserve officials raised the federal funds rate by half a percentage point, making it the seventh increase this year. This increase is smaller than the last four, which were three-quarters of a percentage point. Despite the smaller increase, it may still have an impact as higher interest rates can lead to higher costs for borrowers but also higher yields for savers. A Fed rate increase may not immediately change the rates offered by banks, but it can lead to an increase in some accounts. Banks may also raise rates on savings accounts to attract new customers, putting pressure on other institutions to follow suit.

MORE: Avoiding Common Banking Errors: Maximizing Your Finances with Checking and Savings Accounts

Understanding the Federal Funds Rate: What is it and How is it Set?

The federal funds rate, also known as the “Fed rate,” is the interest rate at which banks lend money to each other overnight. The Federal Reserve states that these transactions occur after hours to fulfill regulatory requirements and manage market conditions. The Federal Open Market Committee, which is part of the Federal Reserve, sets the rate to help implement monetary policy based on economic conditions. The federal funds rate can affect consumers by raising the cost of loans or credit cards, which may result in households borrowing less, leading to lower spending and potentially lower inflation.

Maximizing Savings Opportunities with a High-Yield Account

When the Federal Reserve raises interest rates, it’s a good opportunity to review your savings account options and compare rates. Not all banks may increase their rates, and the average savings account rate can be low, at 0.24% APY as of November 2022, according to the Federal Deposit Insurance Corp.

However, online savings accounts often offer higher rates due to lower overhead costs, such as not having to operate physical branches. This allows them to pass on the savings to customers in the form of higher rates and low or no fees.

A higher annual percentage yield (APY) can have a significant impact on your savings balance. For example, if you have $10,000 in a savings account earning a low 0.01% APY, you would earn only about $1 in interest after a year. But if you put that same amount in a high-yield savings account earning 3% APY, you would earn over $300 in interest after a year. Additionally, the interest earned on high-yield savings accounts compounds over time, earning interest on interest, which can further grow your savings. While high-yield savings accounts may not make you rich, they can help your savings grow significantly more than a low-rate option.

MORE: How Low-Interest Rates and High Inflation Impact Your Savings

Navigating High Inflation: The Importance of Saving and Alternative Options

With high inflation, it may seem that putting money in a savings account is not beneficial as it erodes the purchasing power of your money. However, having a savings account is important for having quick access to funds in case of unexpected expenses and helps prevent going into debt. It is recommended to have at least 3-6 months’ worth of expenses saved in an emergency fund, but any amount saved can help. Even putting away small amounts like $10 a week can add up to over $500 in a year, and having that money earn interest is an added benefit.

If you have a fully funded emergency savings account and extra cash that you don’t need immediate access to, it may be worth considering other short-term options such as inflation-matching savings bonds or certificates of deposit that have higher yields than traditional savings accounts but require you to leave the money parked for a certain period of time. For long-term goals like retirement, it may be appropriate to look into investing options.

It’s important to pay attention to the Federal Reserve’s interest rates as they affect the cost of loans and the yield on savings accounts. For those who have little or no debt and can contribute to savings, an increase in the Fed rate can be a financial opportunity.

MORE: Navigating Inflation: Strategies for Investors to Maximize Returns

Questions Answered in this Article

What is the federal funds rate? The federal funds rate, also known as the “Fed rate,” is the interest rate at which banks lend money to each other overnight. The Federal Reserve sets the rate to help implement monetary policy based on economic conditions.
How can consumers be affected by a federal funds rate increase? Consumers may be affected by a federal funds rate increase by raising the cost of loans or credit cards, which may result in households borrowing less, leading to lower spending and potentially lower inflation.
How can I take advantage of a federal funds rate increase? When the Federal Reserve raises interest rates, it’s a good opportunity to review your savings account options and compare rates. Online savings accounts often offer higher rates due to lower overhead costs, such as not having to operate physical branches.
Why put money in a savings account when there is high inflation? Having a savings account is important for having quick access to funds in case of unexpected expenses and helps prevent going into debt. Even putting away small amounts like $10 a week can add up to over $500 in a year, and having that money earn interest is an added benefit.
What other short-term options can be considered when savings accounts may not be beneficial? If you have a fully funded emergency savings account and extra cash that you don’t need immediate access to, it may be worth considering other short-term options such as inflation-matching savings bonds or certificates of deposit that have higher yields than traditional savings accounts but require you to leave the money parked for a certain period of time.

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