16 - The Fed Explained: What a Rate Change Means for You

You hear "the Fed raised rates" on the news, but what does that actually mean for your wallet? In this episode, we translate the complex headlines into practical, personal knowledge. We'll explain who the Fed is, what their "dual mandate" means, how their decisions directly affect the APY on your savings account, and why the interest rate on your variable-rate credit card goes up when they tighten policy. This episode connects the big picture to your budget.

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Transcript

Episode 16 | The Fed Explained: What a Rate Change Means for You

00:00:00 Daniel Hill: Shanna you see in the news all the time, a headline flashes across the screen. The Fed lowers interest rates again.

00:00:09 Shanna Browning: Oh, absolutely. And actually, that just happened. And it's usually followed by a lot of serious looking people on TV talking about bond yields and economic projections. And for most people watching at home, I think their reaction is, okay, so what exactly?

00:00:25 Daniel Hill: It feels like this big abstract event that happens in a boardroom somewhere far away. You hear that? It's good news for savers, but bad for borrowers. And it doesn't seem to connect to our daily lives at all.

00:00:38 Shanna Browning: That's right. But the truth is, those decisions have a very real direct impact on almost every dollar we earn, save and borrow. And that's our goal today, is to help bridge that gap. So we're going to translate that very confusing headline into what it actually means for your wallet.

00:01:04 Daniel Hill: Welcome back to Making Sense of your Cents. I'm Daniel Hill.

00:01:08 Shanna Browning: And I am Shanna Browning. And today we're going to tackle a topic that's constantly in the news but often misunderstood the Federal Reserve or the Fed.

00:01:19 Daniel Hill: Now, we're not going to get bogged down in complex economic theory. Instead, we're going to focus on the one thing that matters most to you. How do Fed decisions on interest rates affect your savings account, your credit cards, and your mortgage?

00:01:37 Shanna Browning: That's right, Daniel. And let's start with the absolute basics. When we say the Fed, we're not really talking about the FBI or some sort of crazy alphabet agency, right. When we say the Fed, who are we actually talking about?

00:01:50 Daniel Hill: Well, Shanna, that's a good question. The Federal Reserve Bank or the Fed is the Central Bank of the United States. You can think of it as the Banker's Bank. It's an independent government agency, and its main job is to keep our country's financial system stable and healthy. And to do that, Congress has given them two primary goals, which is often called their dual mandate, are interesting.

00:02:19 Shanna Browning: And so what are those two goals?

00:02:20 Daniel Hill: Well, the first is to promote maximum employment. They want the economy to be strong enough that everyone who wants to get a job can find one. And the second goal is to maintain stable prices, which really means keeping inflation under control.

00:02:36 Shanna Browning: Which are pretty big goals. And sometimes two goals can sometimes be at odds with each other. Right?

00:02:42 Daniel Hill: They absolutely can. It's a constant balancing act. If the economy is running too hot, employment might be high. But inflation can get out of control, making everything more expensive. If they try to cool the economy down too much to fight inflation, it can risk slowing down job growth. To manage this balancing act, the Fed has a primary tool that you always hear about in the news. It's the ability to set a key interest rate.

00:03:11 Shanna Browning: Which is an interesting term. And the key interest rate is called the federal funds rate. And so tell me what that is.

00:03:19 Daniel Hill: So the federal funds rate is the interest rate that banks charge each other for overnight loans. Now that sounds technical, but all you really need to know is that this one rate serves as the foundation for almost all other interest rates in the economy.

00:03:36 Shanna Browning: Okay, so when the Fed raises or lowers the federal funds rate, it kind of creates a ripple effect across the entire financial system.

00:03:45 Daniel Hill: That's right. Think of the economy as a big party. The Fed is the DJ. And the federal funds rate is the volume knob for the music. If the party is getting a little too wild and crazy, that's inflation. The Fed turns the volume down by raising the interest rates. This makes it more expensive for everyone to borrow money, which cools things down.

00:04:06 Shanna Browning: And so if the party's dying down and people are leaving in this scenario, that's a slowing economy or a recession. And the DJ turns the volume up to get people back out on the dance floor.

00:04:17 Daniel Hill: That's the perfect analogy. The Fed lowers interest rates, making it cheaper to borrow money, which encourages people and businesses to spend and invest, stimulating economy growth.

00:04:27 Shanna Browning: It's a great way to think about that. All right. So we have the cause. The Fed turns the interest rate knob up or down. But let's talk about the first effect which is our savings. So Daniel when the Fed raises interest rates, when they raise them, what happens to the money in our savings account.

00:04:45 Daniel Hill: Well, this is actually good news for savers. When the Fed raises rates, the interest rate or APY.

00:04:52 Shanna Browning: As we've talked about.

00:04:55 Daniel Hill: That goes up on your savings account. Banks are now earning more money on the money they lend out, so they can afford to pay you more for the money you deposit with them.

00:05:06 Shanna Browning: And what a difference. A huge difference that can make. Yes. So let's put some real numbers on that. A few years ago, in a low rate environment, you might have seen a high yield savings account with an APY of say zero point five zero percent. So on a ten thousand dollars balance, that's a fifty dollars in interest over a year.

00:05:26 Daniel Hill: Right. But now after the Fed has raised rates, it's not uncommon to see Apys of four or even higher on that same ten thousand dollars balance of four percent APY earns you four hundred dollars in interest.

00:05:39 Shanna Browning: Way better.

00:05:40 Daniel Hill: That's a huge difference of three hundred and fifty dollars a year for doing nothing but having your money in the right place at the right time.

00:05:48 Shanna Browning: What a great analogy that is too. But it's also important to know that this doesn't happen instantly or automatically for all accounts, does it?

00:05:56 Daniel Hill: No, that's a critical point. Some banks are quicker to pass on these higher interest rates to their customers than others, especially on standard savings accounts. High yield savings accounts and online banks often react more quickly. And this is why, in a rising rate environment, it's so important to occasionally shop around and make sure your savings are in an account with a competitive APY.

00:06:18 Shanna Browning: And then on the flip side of that, when the Fed starts lowering interest rates, we can expect the APY on our savings accounts to come down as well, right?

00:06:27 Daniel Hill: Correct. It's a double edged sword. The same force that helps your savings grow can also slow it down. The key is to be aware of the environment we're in. If you hear news that the Fed is expected to start cutting rates, that might be a good time to consider locking in a higher rate with the long term certificate of deposit before those rates start to fall. Now, let's kind of switch gears a little bit. Let's talk about the other side of this coin. And that's debt. Shanna how do Fed rates change affect our credit cards.

00:06:59 Shanna Browning: Are credit cards. So this is where it hits people's budgets the most directly, especially with credit cards. Nearly all credit cards have a variable rate. Again, variable means a floating rate, so it moves up and down. So if you look at the fine print in your cardholder agreement, you'll see the interest rate is defined as the prime rate plus a margin of say fifteen percent.

00:07:22 Daniel Hill: And that prime rate is directly tied to the federal funds rate. Right.

00:07:26 Shanna Browning: That's right. It is. And so the prime rate typically moves in lockstep with the Fed. So when the Fed announces a quarter point a zero point two five percent rate hike, you can expect the prime rate to go up by a quarter point almost immediately.

00:07:42 Daniel Hill: Wow.

00:07:43 Shanna Browning: Almost immediately. And that means the Apr on your credit card will also go up by a quarter point within a billing cycle, or two at the most.

00:07:52 Daniel Hill: So let's put some real numbers on that. Say you have a five thousand dollars balance on a credit card. If your Apr goes from eighteen percent to twenty two percent over a period of Fed rate hikes. Your annual interest cost jumps from nine hundred dollars to one thousand one hundred dollars. That's an extra two hundred dollars a year, or about seventeen dollars a month for doing nothing at all.

00:08:16 Shanna Browning: Yeah, that's right. And it's not the best. So it's a huge deal. And it's why carrying a credit card balance becomes so much more dangerous in a rising rate environment. The same thing applies to other variable rate loans, like a home equity line of credit or HELOC for short. Their rates are also tied to the prime rate. So as the Fed raises rates, the cost of borrowing goes up.

00:08:40 Daniel Hill: What about the bigger fixed rate loans like mortgages and auto loans?

00:08:45 Shanna Browning: So fixed rates are a little different and a common point of confusion. The interest rates on new mortgages and auto loans are not directly set by the Fed. However, they are heavily, heavily influenced by the Fed's actions and its outlook on the economy. So when the Fed is raising rates and fighting inflation, it generally pushes the rates for a new long term loans higher as well.

00:09:10 Daniel Hill: But and this is the most important part for current homeowners, if you already have a fixed rate mortgage you're safe, right?

00:09:19 Shanna Browning: Oh yeah. Absolutely. And that's the beauty of a fixed rate loan. If you locked in a three percent mortgage rate a few years ago, it's going to stay at three percent for the full thirty years, no matter what the Fed does. That's why the Fed's actions are most relevant when you are actively shopping for a new loan.

00:09:38 Daniel Hill: Wow. This has been just a wonderful discussion on a very complex topic. And now it's time to build on that understanding with this week's actionable tip.

00:09:50 Shanna Browning: So your action item for this week is the Jargon Buster. The goal is to build your confidence by taking control of one of these complex terms.

00:10:01 Daniel Hill: Here's how it works. The next time you see a financial headline with the term that feels intimidating, it could be Fed funds, rate inflation, quantitative easing, or CPI. Don't just gloss over it.

00:10:14 Shanna Browning: That's right. Don't don't gloss over it at all. Instead, take two minutes. That's all it needs. Two minutes to look it up. Find the definition from a reputable source. But here's the key part. Don't just read it. Your challenge is to try to explain it in your own simple words, whether out loud to yourself or a friend or your family.

00:10:36 Daniel Hill: Yeah. Become your own podcast host.

00:10:38 Shanna Browning: That's right.

00:10:40 Daniel Hill: That act of translating the jargon into plain English is what makes the knowledge stick. It moves from you being a passive listener to an active, informed participant.

00:10:52 Shanna Browning: And I think that's what matters. It's a small habit that, over time, will completely demystify the world of finance and empower you in conversations with financial professionals. Don't be intimidated by big words.

00:11:08 Daniel Hill: Exactly, exactly. Shanna. This is such a great conversation. Oh, yeah. And we'll be back next week to tackle another big headline. And that is inflation. We'll explain what it is and how it impacts your family budget.

00:11:21 Shanna Browning: And until then I'm Shanna Browning.

00:11:24 Daniel Hill: And I'm Daniel Hill. Thanks for making us a part of your week. And don't forget to send us your questions at podcast@fcbtn.com. And subscribe wherever you listen, whether it's on Apple Podcasts or Spotify. We'd love to have you following us.