When the Federal Reserve increases interest rates, it makes debt more expensive. That includes credit card balances, adjustable-rate mortgages and even student loans. But higher rates also mean higher interest paid on savings accounts and other accounts that pay dividends.
The Fed is raising rates because of persistent inflation. The goal is to cool consumer spending, lowering prices and helping businesses. The rate increase is not the end of higher inflation but part of a longer journey to lower it.
When the Fed raises rates, it sets a baseline rate that institutions like banks can borrow at. Those banks then lend money to other firms, including consumers. That baseline rate influences the rates that lenders set for mortgages, credit cards and other debt. We’ve been in a low-rate environment for quite some time, so the increase will be noticeable for most households.
A higher rate makes it more expensive to borrow, which can prompt people to reduce their spending. That cuts demand for goods and services that help businesses generate revenue, which in turn can impact jobs.
A rise in rates can have other effects, including encouraging businesses to save instead of spend money. That can lead to a slowdown in growth, especially for small businesses that rely on bank loans to expand. In some cases, it can also discourage entrepreneurs from starting new businesses because the cost of a loan would be too costly. That’s why it’s important to make wise financial decisions, regardless of whether the interest rate is rising or falling. That includes building an emergency fund, paying off high-interest-rate debt and diversifying your investments.