Interest is the cost of borrowing money or the benefit of saving money. If you’ve opened a credit card or taken out a loan you have seen the interest rate. On the other hand, if you’ve opened a savings account you will see the interest you’ve earned. But, who decides interest and how can you use it to your advantage?
Interest rates are a key tool used by central banks (like the Federal Reserve) to manage the economy. When inflation is rising the Fed will increase interest rates. On the other side, when the economy is slowing down, they may lower interest rates to encourage borrowing.
How this affects us:
Interest affects us in two major areas, savings and debt.
- Loans and Debt
If interest rates are high, it will cost more to take out loans. Your interest rate on your credit cards or any other variable-rate debt may also increase. In periods of high interest rates, it’s especially important to be mindful of your debt and payments. The higher the rate, the more expensive it will be to borrow money. - Savings
On the other side, high interest is what we want to see in our savings accounts. When interest rates are high, banks and financial institutions pay more interest on savings accounts, CDs, and other deposit products, meaning your savings grow faster.
We want low interest when borrowing money and high interest when saving. Of course, this decision is not 100% up to us. But, when taking out debt, we always recommend looking around for the best rate. We also recommend this when looking for banks and savings accounts.
How can you take advantage of changing interest rates?
- Refinancing
Refinancing allows you to replace your current loan with one that has a lower interest rate, which can help reduce your monthly payment, shorten the loan term, or save money over the life of the loan.
During periods of low interest rates, look into refinancing existing debts such as:
– Mortgages
– Personal Loans
– Private Student Loans
– Balance transfers for credit cards
- Savings
Look for a high-yield savings account to hold your cash. In both high and low interest rate environments, a high-yield savings account will be advantageous. Look around at a few different banks to compare your options and make sure the interest is competitive. We generally recommend Ally, Betterment, and Marcus.
- Investments
When interest rates are high, fixed-income products such as CDs may offer better returns compared to a high-yield savings account. These investments lock in your money for a set period (like 6 months or a year) at a guaranteed interest rate, allowing you to earn more than you would in a standard savings account.
- Compounding Interest
One of the most powerful tools in growing your savings is compound interest. When the interest you earn on your savings is added to your principal, and then you earn interest on that new, larger balance, this is compounding interest. Over time, this creates a snowball effect, allowing your savings to grow faster.