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Understanding the Federal Funds Rate and Its Impact on Your Savings

Watching the Federal Reserve issue another rate hike might not be ideal if you’re planning on borrowing money, but it can be welcome news 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 rate that central banks use to 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.

When the economy is in a downturn, such as during the early days of the pandemic, the Federal Reserve typically reduces the fed funds rate. This makes borrowing cheaper, stimulating spending, business expansion, hiring, and economic growth. During the pandemic, the fed funds rate dropped to near 0%.

However, in 2021, the U.S. began experiencing high levels of inflation due to easy access to cash and pandemic-related supply issues. To address this, the Fed increased the fed rate, making borrowing more expensive to encourage companies and consumers to reduce spending and help temper inflation.

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 is used as a base to set consumer loan rates. For instance, the prime rate increased from 3.50% in March 2022 to 8% in March 2023, and rates on consumer products have also risen during that time frame.

In the first quarter of 2022, the average interest rate on a 24-month personal loan was 9.39% APR. By November 2022, it had jumped to 11.23% APR. 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 isn’t great news for borrowers, it does provide an opportunity for savers who want their money to work harder for them while sitting in a bank account. Here are 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. Money market accounts are another option for parking savings at 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 note that interest rates on savings accounts are variable and can also decrease. If you need to borrow while market rates are high, working on your credit is a way to qualify for the best rates possible.

For any mortgage-related needs, feel free to call O1ne Mortgage at 213-732-3074. Our team is here to help you navigate the complexities of the mortgage market with confidence and ease.

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