“Understanding the Federal Funds Rate and Its Effect on Savings”

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Understanding the Federal Funds Rate and Its Impact on Savings

Watching the Federal Reserve issue another rate hike can be daunting if you’re planning to borrow money. However, it can be beneficial if saving is your priority. When the Federal Reserve raises the federal funds target rate, interest-bearing savings accounts often see higher returns. Let’s explore what the federal funds rate is, how it impacts savings rates, and how you can take advantage of rate increases.

What Is the Federal Funds Rate?

The federal funds rate, often referred to as the fed funds rate or fed rate, is the interest rate at which central banks lend money to each other overnight. This target rate is set by the Federal Reserve, which is responsible for creating monetary policy to manage inflation and maintain economic stability in the U.S.

During economic downturns, such as the early days of the pandemic, the Federal Reserve typically reduces the fed funds rate to make borrowing cheaper, thereby stimulating spending, business expansion, hiring, and economic growth. For instance, during the pandemic, the fed funds rate dropped to nearly 0%.

However, in 2021, the U.S. experienced high levels of inflation due to easy access to cash and pandemic-related supply issues. To combat this, the Fed increased the fed rate, making borrowing more expensive to encourage reduced spending and help control inflation.

The prime rate, a benchmark rate set by commercial banks, is heavily influenced by the federal funds rate and is used to determine interest rates for products such as credit cards.

How Does the Fed Rate Impact Savings Accounts?

When the fed funds rate increases, interest rates on savings accounts also tend to rise. For example, in January 2022, the average rate on savings accounts was just 0.06% nationally. Today, the average rate on savings accounts is 0.35%, following multiple fed funds rate hikes through 2022. Some online accounts even offer an annual percentage yield (APY) of over 3%.

How Does the Fed Rate Impact Interest Rates for Borrowing?

The fed funds rate influences the prime rate, which serves as a base for setting consumer loan rates. For instance, the prime rate increased from 3.50% in March 2022 to 8% in March 2023, leading to higher rates on consumer products during that period.

In the first quarter of 2022, the average interest rate on a 24-month personal loan was 9.39% APR, which jumped to 11.23% APR by November 2022. Similarly, the average interest rate for credit cards moved from 16.17% in Q1 2022 to 20.40% in November 2022.

How to Take Advantage of the Fed’s Rate Increases

While the fed funds rate increase may not be favorable for borrowers, it offers opportunities for savers to make their money work harder. Here are some ways to take advantage of the fed funds rate increase:

• Open a high-yield savings account: Earning a higher APY can significantly grow your savings. For example, if you have $10,000 in a savings account earning 3% APY, your balance would be $10,304.53 after 12 months without adding any more money.
• Investigate other interest-earning bank accounts: Locking money into a certificate of deposit (CD) for an extended term while rates are high can help you maintain a high rate of return even if rates decrease. Some financial institutions offer CDs with APYs over 4%. Money market accounts are another option for higher rates.
• Eliminate credit card debt: Paying off debt with variable rates, like credit cards, can help you avoid higher interest charges. Consolidating credit card debt with a low-interest personal loan or using a balance transfer card offering a 0% introductory APR could be a way to get rid of debt.

The Bottom Line

High interest rates on savings accounts can help expedite the growth of your savings, but remember that these rates are variable and can decrease. If you need to borrow while market rates are high, improving your credit can help you qualify for the best rates possible. With Experian CreditWorksSM, you can check your credit score and learn what’s affecting it to figure out how to improve your credit rating. Paying bills on time and lowering your credit utilization are two key steps that can help your credit score soar.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We are here to assist you with the best mortgage solutions tailored to your needs.

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