Pros and Cons of Rising Interest Rates
From savings accounts yielding more to accumulating debt, learn of the pros and cons of increased interest rates.
After more than a decade near historic lows, interest rates have been heading upward as the Federal Reserve seeks to put a lid on the highest inflation in more than 40 years, which has hit consumers in the pocketbook for things like groceries, clothes and appliances.
The Fed raised its benchmark fed funds interest rate, which banks use to determine the interest rates they charge consumers, several times in 2022 and indicated it will continue raising rates until the economy cools substantially. Fortunately, there are signs that inflation, while still high, may be slowing: the Producer Price Index for services, for example, showed its first decline in two years.
Higher interest rates typically slow down the economy since it costs more for consumers and businesses to borrow money. But while higher interest rates can make it more expensive to borrow and could hamper overall economic growth, there are also some benefits. Here’s a look at the pros and cons of rising interest rates, and how you can take advantage of a rising rate environment.
The Pros of Rising Interest Rates
There are some upsides to rising rates:
- More interest for savers. Banks typically increase the amount of interest they pay on deposits over time when the Federal Reserve raises interest rates. Fixed income securities tend to offer higher rates of interest as well.
- Payouts increase. Regular benefits and entitlement payments such as Social Security are indexed to inflation and these will rise with higher interest rates.
- Inflation may subside. One of the main factors driving the Federal Reserve to push interest rates up is concern over inflation, which is at a 40-year high. Consumer prices in November 2022 were 7.1% higher than they were in October of the previous year. Higher interest rates could tamp inflation, leading to lower prices on everything from gasoline to houses.
- A stronger dollar. Higher interest rates typically lead to a strong dollar, which could lower the price of imported goods and also make it cheaper for Americans traveling overseas.
The Cons of Rising Interest Rates
- New loans will cost more. Just as banks are paying more in interest to depositors, they’re charging more to borrowers. Rates on a 30-year mortgage, for example, surged past 6% in September, nearly double their rate a year ago.
- Payments will go up on adjustable-rate loans. New loans aren’t the only debt that’s costing more. Interest rates on existing, adjustable-rate loans, such as credit cards, are also increasing.
- Home equity may decline. Home equity makes up a large portion of many Americans’ net worth. As rising interest rates make owning a house less affordable, home prices start to go down, which could lower the value of your home equity – and your net worth.
- There’s a higher chance of a recession. While the Fed is increasing rates in an effort to rein in inflation, there’s a chance that its efforts will push the economy into a recession. (Some economists believe that the economy entered one earlier in 2022.)
- Stock market volatility may continue. Concerns about the higher cost of doing business and the chance for a potential recession have weighed on the stock market, leading to increased volatility over the past several months. While investors may have already priced some interest rate increases into stock valuations, uncertainty about how high rates will go means that volatility will likely endure.
How You Can Benefit from Rising Interest Rates
- Boost your savings. In addition to contributing more to your savings accounts, you may be able to earn even more on money that you don’t need right away, such as products like CDs. Another option right now: I-bonds, U.S. Treasury issued bonds with rates with two components: a fixed rate and a rate that adjusts for inflation. But you can’t withdraw the money for at least a year.
- Lock in or maintain fixed-rate loans. Rising interest rates don’t impact fixed-rate debts. So, for example, if you refinanced your mortgage to a rock-bottom rate in the last two years, keeping that rate can serve as a hedge against rising rates and inflation in other areas.
- Focus on paying down high-interest debt. The sooner you can pay down your credit cards, or other high-interest debt, the more protection you’ll have against rising interest rates. Direct your extra cash toward paying down those loans or see whether it’s possible to do a balance transfer to a lower-rate card. Another option: consolidating your credit card debt with a lower-rate personal loan.