Interest rates made a dramatic jump after COVID, going from a Fed rate of 0% on March 16, 2022 to 5.25% on May 3, 2023. While the Fed rate doesn't directly correlate to the APR on your mortgage, auto loan, or credit card, it definitely affects your finances — especially if you are carrying consumer debt. 

In this guide, we’ll discuss what the rising interest rates mean for your personal wealth management goals and how you might turn high interest rates to your advantage. 

Understanding Interest Rates and How They Affect You

The interest rate is the percentage of the principal amount charged or earned as a fee for borrowing or lending money over a specified period. Suppose you need to borrow $10,000 to finance a home improvement project, and the bank offers you a personal loan with an annual interest rate of 5%.

If you accept the loan, you'll repay the $10,000 principal amount along with the interest accrued over the loan's duration. The interest rate of 5% is an annual percentage, so to calculate the interest for one year, on a simple interest loan, you can use the following formula:

Interest = Principal × (Interest Rate)

Interest = $10,000 × 0.05 = $500

In this example, you will have to pay $500 in interest over one year on top of the original $10,000 borrowed. If the loan term is longer, such as three years, you'd pay $500 in interest each year for a total of $1,500 in interest over the entire loan term.

High interest rates typically work against you when you borrow money but work for you when you tuck money into savings, certificates of deposit, or bonds.

When interest rates rise, it becomes more expensive for individuals to take out loans, such as mortgages or personal loans. This rise in borrowing costs can have far-reaching effects on various aspects of our personal finances.

Who Determines the Interest Rates?

Many factors and entities go into determining the interest rate on your loan or account. The most well-known is probably the central bank, which in the U.S., we call the Federal Reserve or just the Fed. By adjusting the benchmark interest rate, the Fed aims to regulate the money supply and borrowing costs in the economy.

The Fed's decisions do not directly raise or lower rates on mortgages or credit cards, but they do create a ripple effect on other interest rates, impacting borrowing costs for consumers. The Fed's decisions are influenced by various economic indicators, such as inflation, employment rates, and economic growth. 

By keeping an eye on these indicators, we may be able to gain insights into the potential trajectory of interest rates.

Effects of Rising Interest Rates on Personal Finances

Interest rates play a crucial role in the economy. They affect consumer spending, business investment, and overall economic growth. Rising interest rates can be your friend or foe, depending on whether you are borrowing money or lending it. 

What Impact Do Rising Interest Rates Have on Borrowing Money?

When interest rates go up, borrowing money becomes more expensive.

If you are planning to take out a new mortgage, auto loan, or personal loan, high interest rates will mean you have to pay bigger interest charges on these loans. Your monthly payments will go up, your repayment period will be extended, or both will happen at the same time in order to accommodate for the higher interest costs.

If you have already taken out a variable-rate loan, such as an ARM (adjustable rate mortgage), you will likely see a jump in your monthly payments. These loans have interest rates that are tied to a benchmark rate, such as the Fed rate. As the benchmark rate increases, the interest rate on your variable-rate loan will also increase and so will your payments.

Credit Cards and Personal Loans

Credit card and loan rates also experience the impact of rising interest rates. As the Fed raises interest rates, credit card companies and lenders typically pass on the higher costs to consumers. 

If you are carrying credit card debt, consider taking steps to reduce your reliance on credit cards. Pay off what you can, and stop using any cards that you have a balance on. This could also include creating a budget, cutting unnecessary expenses, and finding ways to increase your income. 

What Impact Do Rising Interest Rates Have on Savings & Investments?

When the Fed increases the interest rates, borrowers pay more, but lenders earn more. That generally means the interest you earn on savings accounts, certificates of deposit (CDs), and other fixed-income investments will rise. Some investors may see this as an opportunity to capitalize on higher returns on these types of investments.

Certificates of Deposit, Cash, and Money Market Funds

One of the first effects of rising interest rates on personal finances is seen in savings accounts and CDs. Banks and credit unions need access to these funds and will generally offer better rates if you want to open one of these accounts. So, if you have been considering opening a new savings account or investing in a CD, now might be a good time to do so.

U.S. Treasury Bond

Bonds tend to offer higher yields when interest rates rise. This can be advantageous for investors seeking fixed income investments. However, prices of existing bonds will drop as new bonds offer higher rates providing the potential for higher future income, thus becoming more attractive to investors than previously issued bonds. It is important to evaluate your time horizon and diversify your investment portfolio, as rising interest rates can also lead to market volatility and potential losses in your investments. . 

Higher interest rates tend to have a negative impact on stocks. As the price of doing business increases, revenue and earnings may decrease, thus lower stock prices. While stocks tend to decline at first, rising rates might also mean the economy is healthy and companies are doing well. 

All areas of investing involve risk, and while short-term opportunity may sound appealing, you’re likely better off in the long run with a cohesive diversified investment strategy to help you accomplish your goals. Discussing your options with your investment advisor is often a good idea.  

Tips for Managing Personal Finances During Rising Interest Rates

Managing personal finances during rising interest rates may require some careful planning and adjustments. But resist the temptation to make any rash decisions in response, instead focus on the basics, 

Here are some tips to consider:

• Review your financial goals. Have they changed since you last revisited them? Consider your investment goals, if they’ve changed, revisit your asset allocation and investment strategy and make sure it aligns with them. If retirement is now in the near future, for example, you may need to shift your portfolio towards more conservative investments.  

• Review and adjust budgeting. Make sure your budget aligns with your goals. Evaluating your budget may allow you to identify areas where you can cut back on non-essential expenses and allocate more funds towards savings or debt repayment if needed.

• Explore 0% balance transfer or debt consolidation opportunities. If you’re carrying a balance on a high interest credit card, look into switching to a card that provides a 0% APR on balance transfers. You’ll have to qualify, and it’s only a temporary reprieve, so make sure you have a strategy to pay off the card over time  If you have multiple debts, consolidating them into a single loan with a lower interest rate can simplify repayment and potentially reduce overall interest expenses. 

• Save for emergencies and unexpected expenses. Having a financial cushion can help cover unexpected expenses without relying on high-interest credit options.

• Diversify investments. In a rising interest rate environment, the value of certain investments may fluctuate. If you are heavily concentrated in a specific company or asset class consider diversifying. Diversifying your investment portfolio across various asset classes can help mitigate risks. 

• Be proactive and stay informed. Monitoring your financial situation and seeking professional advice can aid in making well-informed decisions.

What do Rising Interest Rates Mean for Personal Finances?

Interest rates have risen sharply in the past two years. It’s likely we’re near the top of the rate hikes, but no one can tell you with certainty if they will continue to rise, taper off, or decline in the coming months. We do know, however, that you can help mitigate the negative effects of unpredictable events by carefully managing your personal finances.

By revisiting your expenses and prioritizing variable interest rate debt, you can help mitigate the impact of higher borrowing costs and maintain a balanced financial outlook. 

We recommend that you consult with your wealth management advisor if you have an adjustable-rate mortgage or if you plan to take on a new mortgage in the near future. Mortgage rates play a pivotal role in the housing market, affecting affordability and demand. As rates increase, potential homebuyers likely face higher borrowing costs, making it more important than ever to carefully assess housing affordability.

Investing in bond funds or newly issued individual bonds can be attractive, as yields tend to increase in response to higher interest rates, potentially providing stable income in the future. High-yield savings accounts offer an avenue to earn competitive returns on cash holdings, providing a way to benefit from rising interest rates while maintaining liquidity.

In this dynamic financial landscape, it's vital to not make rash decisions in response. Keep seeking advice from trusted financial professionals, such as the team here at Cooke Wealth Management. Partnering with advisors who can tailor strategies to individual circumstances and long-term goals can provide peace of mind and optimize financial success.

When interest rates rise, it can feel like you are piloting a ship on choppy waters. Rising rates are not necessarily your financial enemy, however. If you stay out of debt and align your spending, savings, and investments with your goals,, you can position yourself to  withstand these turbulent times and craft a secure financial future.