How rising interest rates make borrowing more expensive, benefit savers

The Federal Reserve is signaling that it will raise interest rates above 3% by the end of the year as it struggles to control inflation without plunging the economy into a recession.

The Fed's decision this week to raise the benchmark interest rate by three-quarters of a percentage point, the biggest rate hike since 1994, will cause a ripple effect for borrowers and savers. Higher interest rates make it more expensive to borrow money, while savers stand to benefit -- albeit to a lesser degree.

Higher interest rates make mortgage loans and car loans more expensive. They can also affect floating-rate debt on credit cards and some student loans, said Murray Frank, a finance professor at the University of Minnesota's Carlson School of Management.

"Rising interest rates affect essentially everything," he said.


The average interest rate on 30-year fixed mortgages hit 5.9% on Thursday. That means the monthly mortgage payment on a $350,000 home with a 20% down payment would be $1,670. One year ago, when interest rates were 3%, the monthly payment would have been $1,180.

If the average rate increases to 9%, the same monthly payment would grow by hundreds more dollars, to $2,250.

Rising interest rates have already squeezed some people out of the housing market, but for those who need to buy a home, now's the time, Frank said.

"Bad as it may be, the Fed is telegraphing those interest rates are going up, not down," he said. "So if you delay a few months, the likelihood is the mortgage interest rates will be higher still."

Credit card debt

People carrying floating-rate debt, including credit card debt and some student loans, should prioritize paying that down immediately in an environment with rising interest rates, Frank said.

"You don't want that floating up into the stratosphere," he said. "Pay that off as quickly as you can."

Better for savers

Savers have gotten crushed over the past six months with few placed to invest their money. The stock market is down more than 20% from its early January highs, bond prices have tumbled, and inflation has eroded the value of savings accounts with interest rates stuck near zero.

High-yield savings accounts at online banks will finally jump above 1% in response to the latest rate hike, and they'll climb higher with future Fed rate increases. But that's still modest compared with 8.7% percent inflation in the Twin Cities.

"You may be losing a little bit less, but you’re still losing," Frank said. "Ultimately the savers may be in better shape, but right now the investment opportunities don’t seem great in such a serious inflationary environment."