The Fed increased interest rates again — here's why you should save more and pay off debt in response

In December 2022, the Federal Reserve announced the seventh consecutive increase to the federal funds rate and indicated it intented to continue raising interest rates going forward.

The Fed has repeatedly raised rates in an effort to corral rampant inflation that has reached 40-year highs.  Higher interest rates may help curb soaring prices, but they also increase the cost of borrowing for mortgages, personal loans and credit cards.

Given the current economic outlook and interest rate environment, saving money and paying down high-interest debt have become more appealing.

Below, CNBC Select dives into what you should do with your money after an interest rate hike.

A complex web of factors influences the economy and interest rates in general, making it impossible to predict the future rate environment with absolute certainty. But right now there are no signs rates will be dropping anytime soon, and the Fed says it will continue rate hikes in 2023. And even if the economic outlook suddenly shifts, it’s always a good idea to focus on the fundamentals that put you on firm financial footing. 

That’s why now is a good time to reassess your approach to saving and to take a good hard look at your debt — especially debt with a variable interest rate.

Savings accounts are paying better

During the height of the pandemic, the interest you could earn on money held in a savings account was next to nothing. Even high-yield savings accounts often had APYs under 1%.

But in a world of high interest rates, savings accounts can earn much more considerable returns. Currently, the best high-yield savings accounts offer rates of over 4% with no monthly fees. 

At the time of writing, a UFB Portfolio Savings account can earn up to 3.26% APY with no minimum balance and no monthly fees. And it’s not the only account offering high returns. High-yield savings accounts with LendingClub have APYs of 4.00%.

The cost of borrowing is increasing

While savers have reasons to rejoice during an era of high rates, borrowers may feel the financial pain of increased costs. And if you have debt tied to an adjustable interest rate, you’ll pay more for the money you’ve already borrowed.

One of the best ways to save money during times with higher interest rates is to focus on paying down your debt with the highest interest rate first. The balance on your credit card is often a good place to start, as many cards can easily have an annual percentage rate (APR) of more than 20%. That’s more than double today’s inflation rate and far higher than what you’d earn with a savings account.

An emergency fund is a vital safety net

Building up an emergency fund is a wise decision regardless of the economy’s health.

Your personal circumstances can take a turn for the worst even if the broader economy is doing well. Although there is debate as to how much you should save in your emergency fund, a good target is to have enough funds to cover three to six months of living expenses. And, keeping your emergency fund in a high-yield savings account allows you to earn interest and have your cash work for you.

With inflation, savings rates, and interest rates on debt all at elevated levels, you may have to balance building your savings with paying down debt.

The Federal Reserve is continuing to raise its benchmark interest rate. That means rates for mortgages, personal loans, credit cards, and savings accounts are likely to continue increasing.

Although there are signs that the pace of the increase in rates may be slowing, the Fed hasn’t signaled it will stop with the rate hikes anytime soon. With high rates, saving becomes more appealing, and paying off your debt is even more important.

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