According to our Q3 2022 Consumer Pulse, rising interest rates is one of the top five concerns for Americans in 2022. It’s understandable — a rise in interest rates can impact numerous parts of your financial life.
When interest rates go up, there should be no direct impact to fixed-rate mortgage or auto loans, if you have them. With a fixed-rate loan, the interest rate doesn’t change throughout the life of the loan. However, a loan with a variable interest rate, like a credit card, may go up or down based on changing market conditions.
If you hear that “interest rates are rising”, any loan you have with a variable interest rate may eventually rise as well. Your payments on variable-rate loans and the cost of potential future loans, whether they’re variable or fixed, may rise as interest rates do.
By knowing the basics about how interest rates work and their potential impact on your finances, you can be prepared for rising interest rates.
How your interest rate is determined
Generally, lenders consider multiple factors to determine the interest rate on your loan. This may include your creditworthiness, which they’ll assess by looking at your credit score and credit history. You may be given a particular interest rate based on your creditworthiness, which usually falls in a pre-determined range. You can see this range in the pricing or terms and conditions documents from your lender. This interest rate will then be added to an index or reference rate.
An index rate is a benchmark rate based on changing market conditions. Lenders decide which index rate applies to your loan. For example, credit cards use the prime rate as their index. Banks may change the prime rate based on the Federal Reserve’s federal funds rate, which is often what people are referring to when there’s a discussion about interest rates going up or down.
While these are two important aspects, they may not be the only factors lenders use. You’ll be able to see how your interest rate is calculated in the loan’s pricing and disclosure material. This is important to read before you apply because it can give you a more precise price of your loan beyond marketing materials. Of course, if you have any questions, you should speak to your lender directly.
How rising interest rates impact your accounts
Many credit card annual percentage rate (APR) calculations are based, in part, on the prime rate. So, if interest rates rise, the APR on your credit cards may increase too. Paying off your balance by the due date each month allows you to avoid interest charges on your purchases. If you’re consistently paying off your card in full, rising interest rates may not have much of an impact.
If you do carry a balance month to month, a rise in interest rates may increase how much you’re paying in interest. As a result, it may take longer to pay off your credit card debt. As interest rates change on your credit cards, continue to evaluate whether you should adjust your goals and strategies, like whether to save or pay off debt with any extra funds you may have.
Interest rates for fixed-rate mortgages don’t change throughout the life of the loan. However, if you have an adjustable-rate mortgage, your interest rate could change as interest rates rise or fall. Adjustable-rate mortgages may start with a fixed, “teaser” interest rate. But after that fixed rate expires, your interest rate may change based on the movement of the index rate the lender uses.
Your loan terms will tell you how often your interest rate can be adjusted. A 7 year/6 month loan means the fixed rate lasts for seven years, but after that time period is up can be adjusted every six months.
If you think interest rates will go down or you don’t plan on owning the home after the introductory rate expires, an adjustable-rate mortgage can make sense. On the other hand, if interest rates go up, your monthly payment could as well. You need to be prepared for this possibility if you plan on being in the home long-term.
Mortgages, especially adjustable-rate mortgages, can seem complex, so make sure you completely understand your loan terms before applying. Talk to your lender and mortgage broker, if you have one, about any questions you have.
Credit cards and mortgages aren’t the only accounts with variable interest rates. Home equity lines of credit and even private student loans can have variable interest rates as well.
Rising rates and future purchases
Even if you’re taking out a fixed-rate loan, rising interest rates can still make purchases more costly. Since cars and homes tend to be among the biggest financial decisions people make, even minor changes to interest rates can have a big impact over the life of the loan.
While you can’t directly influence Federal Reserve interest rates, there are some things you can do before shopping for an upcoming loan. Saving up for a larger car or home down payment, if possible, will limit how much money you need to borrow. This can result in significant savings, especially for longer loans. You can use this free mortgage calculator tool to see how your monthly payments and total interest will change based on your down payment.
Working to improve your credit health can also help you secure better interest rates and terms. Prepping your credit before a major purchase, such as by monitoring your credit reports and paying down debt, can help you feel confident before shopping for a loan.
What happens when interest rates rise?
How much rising interest rates impact your overall financial health truly depends on the type of debt you have, how you use it and whether you’re seeking out additional financing in the near future. Your fixed-rate loans shouldn’t see any changes, though loans with variable interest rates can become more costly.
One thing to note: Rising interest rates can also benefit you. As rates go up on loans or credit accounts, they may also increase on savings accounts and savings bonds, which can be beneficial if you’re an active saver.
No matter your credit history, creating a budget and building out a savings plan can help you prepare for the potential impact of interest rate changes on your household finances.