About every six weeks, the presidents of each Federal Reserve Bank meet to discuss the economy and any policy changes. Known as the Federal Open Market Committee, these presidents will often decide whether or not to increase, decrease, or maintain the federal funds rate. The federal funds rate is the interest rate banks charge each other to borrow money overnight.
Many financial institutions look to the changes in the federal funds rate in order to set their own interest rates.
After a long period of low interest rates, the FOMC has recently been slowly increasing the rate in an attempt to combat inflation. Because this rise in interest rates can have an impact on your finances, it’s important that you understand what those are.
As a general rule of thumb, it’s good to keep in mind that higher interest rates help those with savings and hurts those who have debt.
Here are changes you can expect to see and may already be experiencing.
Higher Credit Card Interest Rates
Nearly all credit cards charge variable interest rates. You may get a fixed interest rate for a certain period of time — like a 0% introductory rate — but after the promotional period ends, the rate will fluctuate.
Credit cards typically set their interest rates based on an underlying rate, most often the prime rate, and then they add a margin. So, your interest rate may be the prime rate plus 10%. If the prime rate is 5.25%, then your interest rate will be 15.25%.
As the interest rates rise, the interest rate that your credit cards will charge you on your balance will increase too.
In a rising rate environment, you will want to convert variable rate debts into fixed rate debts and work to pay off your credit card debt. This will help you save money and avoid the increasing interest rates.
Higher Yields on Savings
If you hold your money at your local brick-and-mortar bank, you probably won’t see much of a change as interest rates rise. If you work with an online bank, you’re already enjoying higher interest rates on all deposit products.
Many are now paying over 2% on savings accounts and up to 3% or more on longer-term CDs. A year ago, most were paying a full percentage point less.
If your money is mostly sitting in your local bank, you’re not taking advantage of higher interest rates. You may be paying more on your credit cards and home equity line, but you’re not getting a corresponding increase in interest on your savings. Now is a good time to make that change, if you haven’t already.
Bonds May Lose Value
If you hold any bonds, the value of those bonds decreases as interest rates increase. Though it may seem counter-intuitive, this decrease is because bonds pay out a set amount and the value of the bond decreases if other safer alternatives have increased their yields.
Another general rule of thumb to keep in mind is that for every 1% increase in interest rates for that bond, your bond’s value will fall by a percentage equal to its duration in years. If you hold a 5-year bond and the 5-year bond rate goes up by 1%, your bond will go down 5% in value if you sell before maturity. If you wait until maturity, you still get the face value of your bond but you don’t earn as much interest as you would’ve on a new bond since your rate is locked in.
Equity Investments May Change
If you’re invested in the stock market, you’re probably at least mildly concerned that your portfolio has been less well-behaved this year. The Dow Jones Industrial Average closed out 2017 at 24,719 after having risen 25.1% on the year. The current level is around 24,000, and there’s been a consistent pattern of dramatic declines followed by reluctant recoveries.
If you have some losing stocks, don’t forget that you can sell those losing stocks by the end of the year and offset the losses against your gains. You can deduct a loss of up to $3,000 against your income, and any leftover will carry forward to the next tax year.
Interest on Home Loans
If you have a home loan or a home equity line of credit and have a variable interest rate, you may have seen the interest rate increase and you may now even be paying more interest. One important thing to remember: you can deduct your home mortgage interest on your taxes and the interest on your home equity line of credit as long as the home equity line is secured by your primary residence and was used to build or improve your main home. Under the new tax reform, mortgage interest can be deducted based on a loan amount of $750,000 if it’s taken out after December 15, 2017. Loans taken out prior to December 16, 2017 will still be able to deduct mortgage interest based on a loan amount of $1,000,000.
Interest rates impact many aspects of our financial lives — even those we don’t expect.
However, don’t worry about knowing the tax rules mentioned. TurboTax will ask you simple questions about yourself and give you the tax deductions and credits you’re eligible for based on your entries. If you have tax questions, you can connect live via one-way video to a TurboTax Live CPA or Enrolled Agent to get your tax questions answered. A TurboTax Live CPA or Enrolled Agent can also review, sign, and file your tax return.