You’ll get better savings rates but higher borrowing costs this year
The Federal Reserve is raising borrowing costs to cool the hottest inflation readings in 40 years. The Fed on Wednesday hiked its key short-term fed funds rate to a range of 0.75 to 1 percent, the second of what the central bank expects to be a steady string of increases this year.
Those rock-bottom rates that have starved your savings accounts but made it cheaper for you to borrow are expected to move steadily higher in 2022 and beyond, according to the Federal Reserve. That means it’s time for pre-retirees and those already in retirement to start mapping out a game plan to keep your finances in good order.
Why rates are projected to rise
At the start of the pandemic in 2020, the economy plunged into a brief, sharp recession. The Fed, whose job is to fight inflation and keep the economy growing, slashed its key short-term fed funds rate to near zero and ramped up its bond-buying program to stimulate growth to revive the economy.
The Fed now has pivoted to a less stimulative policy to cool the economy and combat spiking inflation caused by pent-up demand, supply chain disruptions and, more recently, soaring oil prices caused by Russia’s invasion of Ukraine. In March, consumer prices rose 8.5 percent from a year earlier, its fastest pace since 1982. At the same time, the nation’s jobless rate fell to 3.6 percent, moving the job market closer to the Fed’s goal of maximum employment.
The Fed now projects that it will raise its key rate six more times this year, in quarter-point increments. “It’s clearly time to raise interest rates,” Fed Chair Jerome Powell said at a news conference in March, adding that the economy is very strong and well positioned to withstand higher borrowing costs.
A win for income-starved savers
While the Fed’s stimulus was successful in helping bring the economy back from the brink after the 2020 COVID-19 shutdown, it punished savers, especially retirees who rely on safe, steady income. Money stashed in savings and money market accounts, for example, currently pays just 0.06 percent and 0.08 percent in interest, respectively, and a 12-month certificate of deposit, or CD, yields just 0.17 percent, according to the latest data from the Federal Deposit Insurance Corporation.
“Let’s face it: Low yields have been great for people who want to borrow, but low interest rates have been pretty painful for savers,” says Warren Pierson, managing director and co-chief investment officer at money management firm Baird Advisors.
Some of the pain that savers have suffered will subside as the Fed pushes rates higher. “Retirees tend to benefit when rates move up,” says Gary Schlossberg, global strategist for Wells Fargo Investment Institute.
Still, savers shouldn’t expect a lottery-like windfall overnight. Rates are seen moving higher in 2022, 2023 and 2024 to about 3 percent, but they’re starting from such a low base that the gains savers see on cash sitting in money market accounts and CDs will be modest. A $10,000, 12-month CD, for example, that a year from now might pay closer to 2 percent interest, still would generate only $200 in interest each year. And if inflation remains elevated, the returns on your savings still won’t keep pace with the rise in prices for things you buy such as food, gas and furniture, personal finance pros say. “Rates are low, and modest increases aren’t going to change that,” says Greg McBride, chief financial analyst at Bankrate.com.
Don’t expect the nation’s biggest banks to quickly boost the interest they pay on cash each time the nation’s central bank raises rates by a quarter percentage point, McBride adds. Banks are sitting on a mountain of deposits already and don’t need to raise rates to bring more cash in, he says. If you’re intent on getting the highest yield on your cash savings, your best bet is to shop among online banks, which offer far more competitive rates, McBride says.
Borrowers, beware: Costs are going up
If you borrow money, your interest costs will rise on things tied to the Fed’s key rate, such as adjustable-rate mortgages (ARMs), home equity lines of credit (HELOCs), auto loans and credit cards. “All of those things you borrow money to buy will cost more,” says Bill Schwartz, managing director at Wealthspire Advisors. “Maybe the bigger house you were going to buy at a 3.25 percent [mortgage rate] may not be affordable at a 4 percent or 5 percent rate.” One way to offset the hit to your wallet from higher rates is to make sure your credit score is as high as it can be, as banks and credit card companies offer lower rates to lower-risk customers with high credit scores.
And if you are carrying debt on credit cards, expect to pay more in interest, too. “Higher rates are just another form of inflation,” says Bankrate’s McBride. “It eats into disposable income, and paying down debt requires more work.” But there are ways to avoid paying more in interest even as the Fed moves further along in its rate-tightening cycle. If you have a credit card, for example, the best way to keep a lid on interest costs is to pay your debt down as soon as possible, says Ross Mayfield, investment strategy analyst at Baird. Taking advantage of a zero percent balance transfer offer can also make it easier to pay down high-interest debt.
Time is running out for folks who want to refinance their mortgages. If you have an ARM or a HELOC, mortgage products whose interest rates move higher in lockstep with Fed rate increases, it might make sense to lock into a lower fixed-rate mortgage now before the Fed’s next rate hike, says Bankrate’s McBride.
“Refinancing is still very compelling,” McBride says. “And, especially for seniors living on a fixed income that see inflation pushing their costs higher, the ability to refinance their mortgage to cut the size of their monthly payments provides breathing room in their budgets.”
Rate increases, as it turns out, are not the end of the world. And it’s important to keep the news about the Fed’s pivot to higher rates in perspective, says Andy Smith, executive director of financial planning at Edelman Financial Engines. “Try to make sure that [you] are coming into it in the right way and remove as much emotion from it as possible,” Smith says. That means making tweaks here and there to either take advantage of higher savings rates or reduce your borrowing costs, but keeping your long-term investment portfolio, which should include both stocks and bonds, on autopilot. And while rate hikes often spook the stock market in the short term, “most sectors in the S&P 500 stock index muster positive returns in the year that follows the first hike,” says Gargi Chaudhuri, head of iShares Investment Strategy Americas.