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How higher interest rates may hit consumers

Shelly  Gigante

Posted on January 22, 2023

Shelly Gigante specializes in personal finance issues. Her work has appeared in a variety of publications and news websites.
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Describe how the federal funds rate impacts consumers indirectly, but profoundly over time.

Show that rising rates affect new borrowers and those with existing variable rate debt, such as ARMs, home equity lines of credit, and credit card balances.

Warn consumers who carry a credit card balance that they should be wary going forward, and why.

With higher interest rates taking hold, consumers should expect to pay more for car loans, credit card debt, and mortgages in the months ahead, but those who have an emergency fund set aside may also earn more at the bank.

Indeed, a rising interest rate environment impacts consumers differently depending on whether they are a borrower or a saver.

“When rates go up, there is a ripple effect that will likely lead to an interest rate increase on variable rate products,” said Bruce McClary in an interview, a spokesman for the National Foundation for Credit Counseling based in Washington, D.C. “In most cases, it is not a very large change, but even the most insignificant increases can have a major impact on budgets that are very tight.”

The Federal Reserve raised interest rates seven times in 2022 — and at a much faster pace than originally expected in its campaign to combat inflation. Some economists predict rates will climb slightly higher in 2023 before leveling off at “historically high levels.”

Lower interest rates stimulate economic growth by making it cheaper for businesses and consumers to borrow money to pay for things like office equipment and new cars. But low interest rates can also potentially encourage overspending and unwise investment, leading to unproductive economic activity and inflation. The Fed uses its control of interest rates to try and strike a balance between economic growth and inflation.

Interest rates trickle down

The federal funds rate, which is the rate banks charge each other for overnight lending, impacts consumers indirectly, but profoundly over time.

How? Commercial banks use it as a benchmark to set their own prime rate, which in turn dictates interest rates on most home equity loans and lines of credit, credit cards, auto loans, and personal loans — even some small business loans.

A borrower who took out a 5-year personal loan for $25,000 at 4.5 percent interest would owe $466 monthly and pay a total of $2,965 in interest over the life of the loan. If that rate were 5.5 percent instead — 1 percent higher — that same borrower would owe $478 monthly and pay $3,652 in total interest charges.

As such, rate hikes reduce the amount of discretionary income borrowers have for nonessential purchases, including vacations, restaurant meals, and luxury goods. It also impacts how much they can afford to spend on fixed expenses, which reverberates through the economy. (Related: Restoring financial wellness after COVID)

“As interest rates start to go up, it effects how much house people can afford, and therefore the price of homes will come down or stagnate,” said Neil Maxwell, a financial professional with Maxwell Wealth Planning in Parker, Colorado, noting interest rate fluctuations help keep the economy healthy. “It is part of the cycle. Nothing lasts forever.”

The cost of new loans and variable rate debt would rise

It is important to note that rising rates only impact new borrowers and those with existing variable rate debt, such as adjustable-rate mortgages (ARMs), home equity lines of credit, and credit card balances.

If you already own a home with a fixed rate mortgage, have a fixed rate home equity loan, or have a federal student loan (most of which have fixed rates), interest rate fluctuations will not impact your monthly payment.

“Anybody who carries a credit card balance, and anybody considering applying for a new line of credit or mortgage loan should keep a close eye on where interest rates are headed,” said McClary. “It is always a good idea to assume things might change in one direction or the other and prepare for that.”

Existing homeowners with an ARM, in particular, should ensure they are positioned financially to withstand higher monthly payments should interest rates continue to rise.

Some financial professionals suggest homeowners consider refinancing their ARM or higher interest fixed rate mortgage loan now, before rates climb even higher, but McClary said decisions related to long-term loans should never be dictated by interest rate movement alone.

A refi only makes sense, he said, if you plan to stay in your house long enough to offset the closing costs involved — often referred to as the break-even point. Other factors include the rate you are currently paying, the impact on your monthly payment, and whether or not your credit score has changed since you locked in your loan, which would impact the interest rate banks would likely charge you for a new loan.

The same advice is true for those looking to purchase a new car, a home, or take out a personal loan, said Paul Golden, a spokesman for the nonprofit National Endowment for Financial Education in Denver, Colorado, in an interview.

While borrowing costs will likely rise if the Fed continues to raise rates, consumers should stay focused on keeping their debt-to-income ratio under control.

Ideally, said Golden, you want your housing costs, savings, and monthly debt obligations to absorb about 30 percent each of your monthly income. The remaining 10 percent gives your budget a little wiggle room.

Credit card debt

Consumers who carry a credit card balance should be particularly wary going forward, as most variable rate cards are pegged to the prime rate and many charge rates of 18 percent or more.

Households with revolving credit card debt have an average balance of $7,486, according to consumer web site Those households paid an average of $1,380 in interest in 2022, the most recent year for which data are available.1

Be especially careful with retail cards offering zero percent teaser rates for the first 12 to 24 months. Borrowers who fail to repay their balance in full when the grace period ends may get hit with retroactive interest charges. (Related: Handling credit card debt)

“It is true that a lot of people with variable rate credit cards could get into trouble if rates adjust upward and they cannot make substantial changes in other areas of their budget,” said McClary. “It is really a matter of planning ahead and looking at the terms of credit cards when accounts are opened. Think about what that might look like if rates rise and give yourself a financial range to operate within.”

A better savings yield — maybe

Higher interest rates are not all bad news, however.

Savers who park their emergency fund money in a bank or credit union, or purchase money market funds and Certificates of Deposit (CDs), may well see a nominal bump in their yield.

“The silver lining is that higher interest rates means more interest paid in savings, Certificates of Deposit and money markets,” said Golden. (Related: Setting savings goals)

With average savings accounts paying less than 1 percent, however, don’t expect a single interest rate hike (or nine) to make you rich over night, he said.

Indeed, the average savings account interest rate stood at 0.3 percent in January 2023, according to the FDIC.2

Be aware, too, that banks may also not raise their yield on savings accounts immediately after a Federal Reserve rate hike, or at all, said Golden.

In a rising interest rate environment, consumers should consider the impact that higher rates may have on their existing loans, new debt they plan to incur, and their personal savings. But they need, and should not, hit the panic button, said McClary.

“It always makes sense to look in front of you and not make decisions based on assumptions which are nearly impossible to predict,” said McClary. “It is far better to pay attention to your lifestyle, how you are using credit, and how much you are saving than to get too focused on which direction interest rates are heading.”

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This article was originally published in March, 2017. It has been updated.


1 Nerdwallet, “2022 American Household Credit Card Debt Study,” Jan. 10, 2023.

2 FDIC, “National Rates and Rate Caps,” Jan. 17. 2023.

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