The Federal Reserve has raised interest rates seven times since December of 2015. How do these interest rate increases affect consumers?
In theory, rising rates would hurt those who are borrowers and benefit those who are savers. In reality, this is only half true -- borrowers have felt the pain, but relatively few savers have seen much of a benefit.
Instead, the clear winner from recent interest rate increases has been the banking industry.
What happens when interest rates rise: how banks win
An interest rate is the price a lender charges a borrower for the temporary use of the lender's money. That's why rising interest rates are bad for borrowers and good for lenders -- borrowers have to pay more, while lenders earn more.
Consumers are all too familiar with being borrowers, through credit cards, car loans, personal loans and mortgages. What they may be less aware of is that when they put a deposit into a bank, they are effectively lending the bank that money. The bank is obligated to pay that deposit back in full upon request, but in the meantime they are able to use it to fund various business ventures. In return, the bank pays consumers interest on savings accounts and other deposits.
So, when interest rates rise, consumers who borrow money pay their banks and other creditors more in the form of higher interest rates. On the other hand, consumers who have deposits in banks might expect to earn more money on those accounts. All things being equal, this means some consumers should win and some should lose. However, because banks control the interest rates they charge on borrowed money and those they pay out on deposits, things are far from equal.
Since the Federal Reserve began raising rates in December of 2015, average credit card interest rates and other loan rates have risen much more than deposit rates. The following table shows interest rate increases for a variety of examples -- the first three representing borrowed money and the last three representing deposit accounts.
Loan or Deposit Product
Average Percent Rate Increase Since December, 2015
Credit card balances
5-year car loans
Money market accounts
As you can see, the rates banks charge consumers have risen much more than the rates banks pay people for their deposits. To illustrate how consumers are net losers as a result, consider two neighbors, Ruben and Cherise.
Ruben owes a credit card balance of $10,000, while Cherise has just rolled over a 1-year CD worth the same amount. If their interest rates reflect national averages, since the Fed began raising rates Ruben will have seen his annual interest costs rise by $152. Meanwhile, Cherise will have seen income on her 1-year CD rise by just $17. The $135 difference between those two figures means more earnings for the banks.
The gap between lending revenues and borrowing costs for banks is called net interest income, and as that gap widens, net interest income boosts bank earnings. That boost comes at the expense of consumers, which is why banks are loving recent interest rate increases more than they love consumers.
7 ways to fight against interest rate increases
Banks are winning because they have stacked the rising interest rate environment in their favor by increasing the rates that they charge much more quickly than the rates that they pay. Here are some ways you can fight back against this unbalance:
- Cut back on borrowing
This may seem easier said than done, but the fact is that low interest rates are put in place to encourage borrowing, so higher rates should discourage it. You may not be able to cut out borrowing altogether, but incremental changes such as tighter budgeting, making larger credit card payments or delaying purchases in order to save up instead can reduce your exposure to rising rates.
- Work on your credit score
A better credit score can earn you a lower rate on loans and credit cards, so understand any issues on your credit report and work to address them.
- Consider a shorter loan
A shorter repayment term typically means a lower interest rate. For example, as of this writing 15-year mortgage rates averaged 0.54 percent less than 30-year rates -- and would require you to pay interest for half as many years.
- Compare quotes before borrowing
General rate trends are important, but lenders may react to those trends in a variety of different ways. The faster rates are moving, the more variance you might find in what lenders are offering, so this is an important time to shop around before signing up for a loan or credit card.
- Look for break-out banks
MoneyRates has found that a handful of banks are breaking away from the pack and raising savings account and money market rates much faster than the industry norm. If you are a saver, find a bank that is leading the trend towards higher rates, not one that is lagging behind. This simple move can add more than a full percentage point to the interest your savings are earning.
- Pool deposits
If you find yourself with deposits spread across multiple banks, consider pooling them to take advantage of jumbo account rates. Traditionally jumbo accounts have been considered to be those of $100,000 or greater, but some banks offer rate incentives at lower thresholds. Recent years have seen relatively small rate premiums for jumbo deposits, but these may rise as higher rates make having deposits more valuable to banks.
- Consider longer term deposits
Unless you need unfettered access to your deposits, consider locking your money up a little longer in certificates of deposits (CDs). Longer term CDs offer significantly higher rates than savings accounts typically do, and if you employ CD laddering, you can arrange your CDs so they mature at regular intervals to provide liquidity.
Whether you are hurt by or benefit from interest rate increases depends greatly on whether you are a saver or a borrower, but it also depends on your approach to saving and borrowing. Informed consumers can limit the way banks take advantage of rising interest rates.