Editor’s Note: This blog post was written for the Dec. 15, 2016 interest rate increase and updated when the March 15, 2017 interest rate increase was announced.
In the last Federal Open Market Committee meeting of 2016, it was decided that the Federal Reserve would raise interest rates by 0.25%, which is a big deal. This week, in the second meeting of 2017, the Federal Reserve approved another rate increase by another 0.25%, meaning that we seem to be on track for sustained interest rate growth (however slow it might be). We’ve already discussed how these increases will affect your credit card payments, but as a bank customer, what should you expect? Continue reading as we address some of the common questions and concerns that typically accompany interest rate increases.
Will banks increase savings and CD interest rates?
Yes — eventually. Although oft quoted wisdom suggests that higher interest rates mean higher savings for bank account holders, there are a lot of variables at play. Without getting too technical, it’s important to note that the Fed’s decision doesn’t change interest rates directly, it changes the rate at which banks lend to one another (called the federal funds rate). It’s up to financial institutions themselves to set corresponding interest rates based on that metric.
A federal funds rate increase causes the cost of lending between banks to rise, which means that, essentially, business becomes more expensive for banks. Banks pass on this increased expense partly by raising interest on money and credit lent to consumers. This is why credit cards, for example, almost immediately reflect changes in the Fed’s set rate, while savings accounts usually take longer. Banks are most incentivized to raise interest rates for savings accounts and CDs when the federal funds rate is high (even higher than it is now), and when they need to attract more depositors. Interest rates are currently still very low and banks, for the most part, have little reason to seek out new depositors. When one of these two factors change, we could (slowly) begin to see change in savings account and CD earnings.
The big exception to this, however, might be online savings accounts. Facing more competition and less overhead than their brick-and-mortar counterparts, online banks have a lot of reasons to offer competitive interest rates. It’s possible that if online banks believe the Fed will increase rates, they’ll very gradually begin to increase their savings rates. Still, savers likely won’t be seeing anything good, even from online banks, until much later.
When can I expect higher rates on CDs and savings accounts?
It’s not clear. One of the things everyone is looking for is a sustained commitment from the Fed to raise rates. One-quarter of a percent in the grand scheme of things is a pretty small change. In fact, one of the only reasons why it’s garnering attention is because the economy has been in a low interest rate environment for a long time. This means that any change, no matter how small, becomes a pretty big deal. If the Fed is intending to increase interest rates on multiple occasions between now and 2018, then we could potentially start seeing saving account and CD rate increases sooner rather than later. Though the Fed’s policy is not set in stone, a few experts are suggesting that if President Trump is serious about his administration’s infrastructure spending policies, the Fed might begin more regularly increasing rates to curtail any potential resulting inflation. The Fed itself projected three increases in 2017, and so far we’ve had one. It should be noted, though, that its projections aren’t always accurate because the decision to apply increases are tied to the political and economic environment at the time the decision is made. If the Fed feels the time isn’t right, it will hold off on raising rates, as it did after Brexit.
What should I do with my money in the meantime?
Changes in the federal funds rate shouldn’t alter your financial plans. There are plenty of reasons, outside of high interest payments, why you’d want a savings account. On the other hand, CDs are most attractive when interest rates are much higher. Given that your money is being locked in for a set period of time with a CD, a gain at the present rate of 1% or even 2% over the course of five years might not make opening a CD now worth it, especially if the Fed will raise interest rates at any time in the next few years. As such, it’s probably in your best interest to hold off and keep an eye on what rates online banks are offering for CDs or savings over the course of this year. Better yet, you may want to open an online savings account now, as it’ll earn you more interest than a brick-and-mortar bank, while you wait for CD rates to climb.
Outside of that, paying down any debts you have, especially credit card debts, might be useful given that rates are set to increase slightly. Also if you’re looking into any loans, like a mortgage, personal loan or auto loan, don’t feel compelled to jump into them right now. While it seems sensible to assume rates will immediately skyrocket on these items, that assumption might not be warranted and it’s not wise to jump into any loan before you’re ready. As the Washington Post reported, after 2016’s rate increase the interest on mortgages fell and the rate on auto loans barely changed. In most cases, your best course of action is to not overreact to interest rate changes, especially ones that are fairly small.
For more information about online savings accounts, banking and finance, have a look at our personal finance blog, where you can get the information you need to know in order to make informed decisions about your money.