Federal Reserve interest rates: How they affect you

What is the Federal Reserve?

The Federal Reserve is the nation’s central bank. It was founded in 1913 to help stabilize the economy on two major fronts: managing inflation and supporting job growth. To do that, the Fed sets monetary policy that affects the money supply and overall credit conditions.

The role of the Federal Reserve in the U.S. economy 

The Federal Reserve helps keep the economy stable by managing monetary policy, regulating financial institutions, protecting consumer rights and fostering economic development. While the Fed doesn’t directly set mortgage rates, it does control the federal funds rate, which dictates how much it costs everyone to borrow money, from banks to hopeful home buyers.   

How the Fed controls interest rates 

The Federal Open Market Committee (FOMC) is a 12-member group of banking bigwigs from around the country that decides on the Federal Reserve’s monetary policy, including the federal funds rate. They meet eight times per year and make rate changes based on economic needs.

The federal funds rate explained 

The federal funds rate is the interest rate U.S. banks must pay to borrow money from each other overnight. Let’s put that into context. When inflation climbs above the target range of 2%, the FOMC raises the Fed rate. Banks, facing higher borrowing costs, often pass them on to consumers, making car loans, student loans and mortgages more expensive.  

When borrowing becomes more expensive, consumer demand for goods and services tends to decrease, which can lead to lower prices. This slowdown in spending helps cool the economy. Ultimately, the Fed uses this approach to bring inflation down and keep the cost of goods and services in check.

Tools the Fed uses to raise or lower rates 

The Fed has a series of levers that can be pushed or pulled to help steer the economy. The most powerful of these is the federal funds rate, but there are others, too. Through open market operations, the Fed buys or sells government securities to influence the money supply.  

Then, there’s the discount rate, which is the interest rate banks pay to borrow directly from the Fed. Finally, the Fed manages reserve requirements, which dictate how much money banks must keep on hand rather than lend out.

Impact on mortgage rates 

While the Fed doesn’t set mortgage rates directly, it certainly plays a big role. As previously discussed, the federal funds rate shapes borrowing costs. When the Fed raises rates, banks have to shell out more to borrow funds and typically pass those costs on to consumers, driving up the prices on financial products, including mortgage rates.  

If the economy is sluggish and needs a jumpstart, the Fed may lower rates to encourage borrowing and spending. That’s exactly what happened during the pandemic: the Fed slashed rates to near-zero levels, helping make homeownership more affordable during a time of economic uncertainty. If you’re curious about where the market stands now, check out today’s mortgage rates.

Effect on credit cards and loans 

Credit cards and loans tend to follow the same pattern as mortgage rates when the Fed adjusts rates. When rates rise, borrowing becomes more expensive, leading to higher interest on credit cards, loans and other forms of debt and making it more difficult for people to borrow money. Conversely, when the Fed lowers rates, the cost of borrowing decreases and credit becomes more affordable.  

Changes to savings and deposit rates 

Borrowing costs and savings rates tend to move in the same direction. That means when borrowing is cheap, your savings rate is low as well. On the flip side, when rates are high, borrowing becomes more expensive, but savings accounts and CDS offer better returns. In general, it’s smart to borrow when rates are low and save when rates are high.

The Federal Reserve, as the nation’s central bank, changes interest rates to maintain balance in the U.S. economy. These decisions—whether to raise the federal funds rate or implement rate cuts—are influenced by a variety of economic indicators, including inflation expectations, unemployment rates and overall economic growth. 

Inflation, employment and economic growth goals 

The Fed changes interest rates to manage three goals: limiting inflation, encouraging job growth and stimulating economic activity—all while keeping a stable supply of money.  

Rate hikes vs. rate cuts: what triggers each? 

You can think of rate hikes and rate cuts like adjusting a thermostat. When the goal is to cool down the economy and reduce inflation, rate hikes raise the cost of borrowing to dampen consumer spending. When the aim is to heat things up, Federal Reserve rate cuts lower the cost of borrowing to stimulate consumer spending.

Home buyers and mortgage refinancing 

The best time to buy or refinance is when interest rates are low. For refinancing, aim to act when current rates are at least 1% lower than your existing mortgage rate.  

You’ll also need to choose between a fixed-rate mortgage or an adjustable-rate mortgage (ARM). In a low-rate environment, a fixed-rate mortgage will ensure you lock in a great rate for the life of the loan. If you choose an adjustable-rate mortgage, you will be vulnerable to rate hikes after the initial fixed period. 

Debt holders: credit cards, auto loans and HELOC 

You guessed it—the best time to apply for a credit card, auto loan or HELOC is when rates are low, so you can avoid paying an arm and a leg in interest. In a high-rate environment, be sure you’re on solid financial ground before taking on debts with higher interest.  

 Savers and investors: What to expect 

Looking to make the most of any rate environment? If you’re a saver, your earnings will rise when rates are high and fall when rates are low. If you’re an investor, your strategy isn’t as cut and dry.  

 For your current investments, rising rates can increase borrowing costs for companies, potentially leading to lower stock prices. However, if you’re looking to buy new stocks at a discount, a high-rate environment may work to your advantage. As always, consider your current financial situation and goals before making big moves.

Monitor Fed meeting dates and economic indicators 

The FOMC meets eight times a year, and you can follow its schedule here. Keep track of the economy and rate change projections around those key dates to strategize the best approach.

Speak with a Mortgage Specialist 

The state of the economy is always in flux, so it’s a good idea to get advice from a financial advisor before you make big decisions. Luckily, Citi has your back and can help you weigh the pros and cons with your goals in mind.