Changing interest rates can ruin even the best-laid financial plans. If you’ve ever shopped for a new car or home, you know it can take months of careful planning. Before you even start shopping, loan payments must be calculated using the current interest rates to decide how much you can spend. If interest rates rise before you lock in your loan, your $500 monthly payment can suddenly increase to $650. Just like that, a new car no longer fits into your monthly budget. 

Understanding how interest rates affect personal finance is crucial. From how much money you earn in savings to how much you owe in monthly loan payments, interest rates affect your financial position. This comprehensive guide aims to demystify interest rates and their impact on various aspects of your financial life. 

"Interest rates are to asset prices what gravity is to the apple. When there are low-interest rates, there is a very low gravitational pull on asset prices." _Warren Buffet

Interest Rates and the Economy 

Several factors, including the policies of central banks, market demand for credit, and national economic health, determine the level at which interest rates are set. Economic policy, inflation, and global economic events are key influencers of interest rates, making them a dynamic and vital aspect of the financial world.

Like the Federal Reserve, central banks adjust rates to control inflation and stabilize the economy. When the economy needs a stimulus, interest rates fall to encourage spending and make loans more affordable. If the government wants to curb rising inflation, interest rates will rise. Rising interest rates are meant to discourage borrowing and entice consumers to save.

Calculating Loan Payments

Many Americans feel the impact of interest rates on their credit card payments, auto loans, and home mortgages. Interest rates are essentially the cost of borrowing money, expressed as a percentage. Higher interest rates mean more expensive borrowing, affecting monthly payments and overall loan affordability. If you are thinking of applying for a loan, be aware that there are two types of interest rates. 

Fixed Interest Rates - If you secure a loan with a fixed interest rate, the interest rate you receive at closing will not change over the life of your loan. In times of rising interest rates, consumers who have locked in lower interest rates are spared an increase in their monthly loan payments. 

Variable Interest Rates - If your loan has a variable interest rate, changes in the economy can impact your monthly loan payment. As market rates rise or fall, so will your monthly payment. Variable-rate loans are less predictable than fixed-rate loans and can cause your loan payment to skyrocket unexpectedly. 

If interest rates change dramatically over the life of your loan, refinancing is an option. Refinancing your loan can potentially lower payments or shorten loan terms. There are fees associated with refinancing, so talk to your local Dieterich associate to find out if refinancing a loan would benefit you. 

One advantage of buying a home during inflation that you might not immediately consider is the potential for having more purchasing power today than the future.

Impact on Savings 

Interest rates can strongly influence your desire to save money. When interest rates rise, savings accounts and Certificates of Deposit (CDs) typically offer higher returns. Higher interest rates encourage consumers to invest in savings, which, in turn, helps slow nationwide spending. In a low-interest environment, traditional savings accounts yield a very small return. This prompts consumers to try alternative investment strategies and invest in real estate.

True Value of Saving

If you are trying to decide if it’s a good time to save, you need to understand the effects of inflation and real interest rates. If prices of common goods and services are expected to rise by 2 percent over the next year, that economic inflation is going to cut into the value of your savings. You can calculate the real interest rate on your savings by subtracting the rate of inflation from the advertised interest rate on your savings vehicle. Using this equation to determine the real interest rate can help you better evaluate the benefit of saving. 

Here’s an example. Let’s say you put money into a savings account that earns 4.9 percent interest over the year, and prices rise by 2 percent that year. The real interest rate earned on savings was only 2.9 percent (4.9 percent interest minus 2 percent inflation). In this example, the purchasing power of your savings increased by 2.9 percent despite the rise of inflation. This may indicate that it is a good time to save money.

The higher your annual percentage yield (APY), the faster your money grows and you get a better return than you would with a traditional savings account. Look for high-yield accounts.

Effect on Purchasing Power

Purchasing power is the amount of goods and services that you can buy with your money. In recent years, most Americans have seen their purchasing power decline. What used to cost $1 might now cost $1.75, so the amount of goods that dollar buys has decreased. Calculating the real interest rate on an investment helps protect your purchasing power.

In times of high inflation, a savings account may not offer enough interest to create a sound investment. If a savings account offers 2 percent interest and inflation is expected to be 3 percent next year, setting money aside into savings would create a 1 percent loss of your purchasing power. Understanding interest rates and the effects of inflation are important to maintaining your financial health.  

Adapting to Interest Rate Changes 

While global economic policy may seem confusing or even downright boring, staying informed about interest rate trends is vital. Take control of your financial health this year by adopting habits that will maximize your savings, minimize your loan payments, and protect your overall purchasing power. Some helpful strategies include:  

  • Regularly review your financial plan and adapt your savings and spending to match the current economic environment.
  • Browse current savings, checking, and investment accounts for the best interest rates.
  • Tailor your monthly budget to account for inflation and changing loan payments.
  • Seek professional advice when making significant financial decisions. Financial experts, like those at Dieterich Bank, can provide valuable insights tailored to your personal situation.

"Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the longer run." -Jerome Powell

Making the Most of Your Money

Interest rates are pivotal in personal finance, influencing everything from savings to investments. Understanding these impacts is key to making informed financial decisions for residents of Dieterich, Effingham, Newton, St. Elmo, and surrounding areas. Remember, the bankers at Dieterich Bank are always ready to assist you in navigating these financial waters, ensuring you make the most of your financial opportunities in any interest-rate environment. 

Ready to make the most of your money? Contact your local banking team today. We are conveniently located across Illinois, with branches in Dieterich, Effingham, Newton, St. Elmo, Breese, Edwardsville, Red Bud, Columbia, Waterloo, and Chester. Our team is made up of your friends and neighbors whose top priority is your financial success.