For the first time in nearly a decade, the Federal Reserve raised the prime interest rate (Jan. 2016). If you have not had this experience before or given the time since the last increase, you may want a reminder about what such an increase means.
The fact that the prime interest rate has gone up is generally a good sign for our economy as a whole.
Unfortunately, a prime rate increase is also an indicator for an increase in our individual family or business expenses which will typically cost us more money to pay the same bills.
The government manages this process and uses it to control a variety of economic factors, including inflation and unemployment.
Prime Interest Rate Increase Pitfalls
If you have an adjustable rate loan (including many credit cards and student loans), your interest rate will go up. When you notice the increase in your payment amount, it’s probably not because your credit union, bank or credit card company chose to raise your bill – although some of the amount increase could be, if those institutions added an increase in conjunction with the Federal Reserve increase.
The most noticeable payment increases will likely be in any adjustable rate loan you carry because the adjustable rate loan amounts are typically tied to the prime rate. In other words, when the Federal Reserve raises rates, the bill for adjustable rate loans goes up regardless of which lender provided the loan. We end up paying more in interest for each billing cycle, which we’ll find reflected on our next statement.
The rate hike is only a 0.25% increase, which amounts to one dollar in interest for every $400 in principal, so the effects shouldn’t be substantial on small loans. Larger loans, however, may have us feeling the pinch.
How to Take Advantage of the Prime Interest Rate Increase
The good news is if you have a fixed-rate loan, your bill will not be affected. Many mortgages, home equity or business loans are fixed-rate loans.
If you have a high balance on your credit cards, student loans, adjustable-rate mortgage, or any other adjustable-rate loan, it may be a good time to consider turning that debt into a fixed-rate alternative in the preparation of the Federal Reserve raising the prime interest rate again.
Lastly, the interest paid on your savings account, money market account and new share savings certificates will go up. A higher prime rate makes savings products more valuable, so with the volatility in the stock market, you might prefer the relatively low-risk proposition of savings products that financial institutions may offer.
Be sure to connect with your financial advisor to find out what will work best for you with this Federal Reserve prime interest rate change.