CEO and Founder of Plinqit, the only savings app of its kind that pays users for learning about finance and savings.
As inflation quickly rose in 2021 and 2022, the Fed began raising rates, increasing them from a range of 0%-0.25% at the start of March 2022 to 5.25%-5.50% by the end of July 2023. The Fed has since paused its rate-hiking agenda as inflation has cooled from the 2022 peak.
For consumers who have never navigated a high interest rate environment, it can feel challenging to understand how market dynamics affect their financial health.
Let's break down some of the benefits and constraints imposed by the current federal funds rate, as well as implications for consumers and how financial institutions can attract and serve customers.
Less Borrowing
The Fed doesn't set the interest rates credit card companies, mortgage lenders or car dealers charge. However, these institutions' prime rates are based on the federal funds rate. The prime rate acts as a "floor" for the annual percentage rate (APR) of various loans and forms of credit; it's the lowest rate lenders charge their most creditworthy customers.
In the case of credit cards, the APR is almost always variable. That means a consumer's credit card bill will increase within one to two cycles as the federal funds rate rises. If the rate goes up by 0.25% and the card's APR is 23.10%, it will soon be 23.35%, and the consumer will pay more interest on the balance. The APR won't affect a person's bill if they pay off their balance monthly.
Mortgages can also have variable or fixed rates. Many people refinanced their homes during the low-rate environment of the pandemic. Today's homebuyers face mortgage payments that feel eye-wateringly high. On the flip side, homebuyers can try to refinance their homes when rates drop.
The APR on auto loans has also increased with the fed rate, but many dealers are willing to offer attractive rates so they can sell more cars. Shopping around for dealer financing is a good way to keep costs down on a vehicle purchase.
Most people focus on their monthly payments rather than the overall cost of a loan or credit card balance. That's understandable; however, I encourage borrowers to always look at the total cost of a loan to avoid regret down the road when the total cost is more obvious.
Paying down high-interest debt is wise in the current rate environment. However, many consumers also want to use high interest rates to their advantage, saving for a down payment or simply waiting until borrowing gets cheaper. Depositing money with a bank is a safe way to grow one's nest egg or rainy-day fund.
More Saving
A high federal funds rate encourages people to deposit money in banks where they can earn a modest rate of return—compared to investments where the return could be much higher and riskier.
Financial institutions want loans to generate revenue, but they need deposits to lend safely and comply with government regulations. Savings accounts, certificates of deposit (CDs) and money market accounts are three common products that banks offer to attract and hold deposits.
Each institution sets the interest rates on those products to help achieve their deposit targets and preserve their bottom line. The tricky part for banks? Attracting new depositors and keeping them as loyal customers.
Vehicles For Saving
Thankfully, the current rate environment has given the humble savings account fresh appeal, which is excellent news for people looking to earn a safe return.
As a rule, a CD's APY is higher than the APY for a savings account. This is because money in a CD is locked from withdrawal until the CD matures in three months to five years.
However, money in a savings account can be withdrawn on demand or limited to a few times a month. The downside of a conventional savings account is the very low APY.
High-yield savings accounts are another way to go. A high-yield savings account is often preferable to a CD because it blends a high APY with the flexibility to deposit and withdraw money as needed, sometimes with no minimum deposit requirement (or a low minimum deposit).
When paired with a good user experience, a high-yield savings account boosts consumers toward their financial goals. Consumers, especially younger generations, care about improving their financial habits and working toward their savings goals. Plinqit's 2022 State of Savings report found that young adults are significantly more likely than their older counterparts to be saving money. They also expect their financial institution to help them in these endeavors.
The Win-Win For Consumers And Financial Institutions
The internet fueled fierce competition among financial institutions and, more recently, neobanks offering high-yield savings products. Many institutions are trying to win consumers by offering the highest rate, but they're attracting "rate shoppers." These people are willing to spend time finding the highest rate and will move their money as soon as the rate changes.
The good news? A higher rate isn't the only way to compete. Providing a better banking experience with educational resources designed to help people save and improve their financial habits long-term can benefit everyone. Balancing higher rate offers with tools that help customers live their best financial lives can help financial institutions grow their average account balances.
It's important to note, however, that everyone's financial situation is different. Someone who has poor credit and needs to improve it has different needs than someone who wants to learn how to invest. Some people may need help sticking to a budget, so zero-based budgeting tools may be most relevant.
Also, consumers should never underestimate the power of financial advice from professionals or online resources. For example, websites such as Investopedia, The Balance and NerdWallet offer valuable insights into personal finance topics, investment strategies and money management tips. These resources can also help consumers understand which product or tool is best suited for their current needs and goals—whether it’s a certificate of deposit or a high-yield savings account, or something else entirely.
Knowledge is power—and it’s important for consumers to empower themselves and their financial decisions by learning how to effectively manage their finances. When looking for a personal finance, savings product or budgeting tool, consumers should consider what will not only help grow their bank account but also help them grow their financial literacy. Being financially literate will allow them to confidently manage their money.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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