What are the financial benefits of higher interest rates? Experts explain
A key long-term Treasury rate hit its highest level in nearly two decades earlier this month, even before the Federal Reserve raised benchmark borrowing costs.
The Fed hiked interest rates a quarter of a percentage point in an effort to battle back a monthslong surge of inflation. The rise in borrowing costs pushed up rates for loans like credit cards and mortgages, threatening to worsen a budget crunch as shoppers weather price hikes for gas and other essentials.
Those dangers, however, come along with potential financial benefits, some experts told ABC News. The hike in borrowing costs directly benefits savers, who stand to gain from an uptick in the interest yielded by accounts held at banks, they said.
Financial products like high-yield savings accounts and certificates of deposit, or CDs, provide options for investors eager to take advantage of the favorable environment for savers, they added, though such products carry limitations of their own.
"Higher interest rates incentivize people to park money in the bank and spend less of it," James Cox, a financial advisor and managing partner of Virginia-based Harris Financial Group, told ABC News. "If you're a person who has accumulated assets, higher interest rates can be beneficial."
Interest rate hikes make it more lucrative for banks to hold money, which in turn puts pressure on financial institutions to pass along some of those earnings to depositors through higher yields.
As a result, some banks have bid up each other's yield offerings to attract customers.
The average return on a savings account in the U.S. registered at 0.64% annual percentage yield as of Tuesday, marking a slight increase from 0.62% annual percentage yield last month, before the Fed's rate hike, Bankrate data showed.
An incremental uptick in interest rates for savings accounts or other funds may provide a modicum of financial benefit, but it is unlikely to dramatically improve a household's income, Cox said.
"It's not going to materially change the interest-rate picture for a family's savings," Cox said.
Even so, analysts said, investors can avail themselves of products that make the most of higher interest rates, such as high-yield savings accounts and CDs.
Financial institutions have not settled on what exactly constitutes a high-yield savings account. But the name indicates the key characteristics of this financial product: a savings account that delivers high returns.
While no specific threshold earns an account the moniker of "high-yield," the enhanced savings from such accounts can prove substantial, some analysts said.
High-yield savings accounts offer customers as much as 4.2% annual percentage yield, Bankrate data showed, putting interest rates well above the nationwide average of 0.64% for savings accounts.
"As a saver, you can make more money in a high-yield savings account," Kate Ashford, lead wealth writer at NerdWallet, told ABC News. "There's no real downside."
The annual inflation rate currently stands at 3.4%, meaning price increases outpace the average interest yielded by savings accounts at banks. As a result, the purchasing power of money kept in a savings account can drop, even as the total dollar amount increases, Ashford said.
"A high-yield savings account can prevent inflation from eating away the value of what you've got," Ashford said.
In some cases, the interest rate on a high-yield savings account increases automatically in response to a rate hike at the Fed.
"A high-yield savings account of my own saw an increase within 24 hours of the Fed's announcement," Ashord said.
A CD, meanwhile, is a type of savings account that offers a fixed interest rate over a given period of time. If depositors remove their funds before their agreed-upon end date, however, they incur a penalty.
Financial institutions often offer CDs at elevated interest rates in the aftermath of a rate hike at the Fed. Typically, long-term CDs spanning three or five years deliver higher interest rates than short-term CDs, since a wider time horizon requires investors to part with their funds for a longer period.
High-yield savings accounts and CDs carry some downside, however. The interest rate promised by a high-yield savings account or a CD means it lacks the possibility of enormous gains, unlike a riskier instrument such as the stock market, some analysts said.
"In the stock market, you have the potential to make more on your money over time," Ashford said.
Still, Ashford added, a high-yield savings account or CD "gets your money moving in a forward direction."
