How Rising Interest Rates Could Save Americans’ Finances

The Fed has hiked interest rates three times this year. Will it bump up our savings?


In April 2017, the U.S. personal savings rate — the proportion of disposable income Americans don’t spend — was 5.3 percent. Although it has more than doubled from its historic bottom of 1.9 percent in July 2005, it’s still shy of the 11 percent spike it hit in December 2012. The recent interest rate hikes brought on by the Federal Reserve might attract depositors seeking greater returns on their savings accounts, but there are a host of other factors driving how much (or how little) Americans save.

The End of Conspicuous Consumption?

Americans love to borrow. One of the reasons why individuals and corporations take on debt is because interest expenses are tax deductible. Your financial planner might tell you that the best reason to own a house instead of renting an apartment for the same amount of cash per month is that interest is deductible on a mortgage loan and not on a rental payment. And what do Americans do with that extra dough? Buy things we don’t need to keep up with those around us. It’s called “conspicuous consumption” and the U.S. is the world’s frivolous spending leader. However, rising interest rates force consumers to become more thrifty, buying gas station coffee instead of Starbucks lattes.

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See: Signs You Have a Spending Problem

Make More, Save Less

Most of us depend on our paycheck as our main source of income. Of course, we can save more of it the bigger it is. Unfortunately, most Americans just barely squeak by. According to the U.S. Census Bureau, median household income is still below its 2007 pre-Great Recession peak. It’s even below the level it was at the beginning of this century. That’s one of the contributing factors to the country’s desolate savings rate. Sadly, we’ve found that nearly 70 percent of Americans have less than $1,000 tucked away. The middle class just isn’t seeing enough money come in to boost their savings.

So what should we do in the face of rising interest rates? Anand Talwar, deposits and consumer strategy executive from Ally Bank, urged Americans to create a savings strategy. “Before the financial crisis, more than one-third of consumer deposits were in CDs,” he said, referring to certificates of deposit. “Today, less than 10 percent of deposits are in CDs. As rates rise and returns on CDs for some banks become respectable, a lot of this sleepy money will wake up, and more consumers will begin shopping for better deals on deposit accounts to put their hard-earned money to work for them.”

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There’s an inverse relationship between age and savings. A 2014 Moody’s Analytics study found that millennials up to age 34 had a negative 2 percent savings rate, meaning they were spending more than they were saving. The next group, ages 36 through 44, saved 3 percent. And those ages 45 to 54 saved 6 percent. You get the trend.

The problem is that as America ages, these workers transition from saving big to spending bigger in retirement. By 2024, the Bureau of Labor Statistics predicted that the fastest growing group of the U.S. labor force would be ages 55 and older, increasing nearly 20 percent from 2014. This demographic trend could dampen America’s savings rate as that group nears retirement.

Related: More Than Half of Americans Will Retire Broke

The Rich Get Richer

Wealth inequality in the U.S. is bad and worsening — as of 2016, the top 1 percent of America earned roughly 20 percent of the country’s income, according to the Atlantic. If this trend continues — and there’s no inkling that it’ll reverse — our savings rate will be held back by lack of broader participation.

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Debt crowds out savings. Since the peak of the Great Recession in the fourth quarter of 2007, the amount of money Americans dedicate to paying loans has dropped from 13.2 percent of disposable income to less than 10 percent in the last quarter of 2016. However, just as mortgage debt swamped America and led to a financial crisis in 2007, another cloud has formed on the horizon that might lead to our next recession. It’s $1.3 trillion in student loans that are defaulting at an increasing rate. According to personal finance marketplace Make Lemonade, America has 44 million student borrowers. Furthermore, the average student who graduated in 2016 left campus owing $37,172. That means even those who are able to get jobs won’t be saving anytime soon.

As rates rise and debt becomes more and more expensive, marginal borrowers are forced to cut back. This is a fiscal discipline mechanism that may be frustrating for the jilted borrower, but good for our economy in the long term. Leading to the Great Recession in 2007, scrupulous mortgage brokers lent too much money to unqualified borrowers to buy homes they couldn’t afford. Of course, then the roof caved in when these weaker borrowers defaulted. The housing bubble popped and home prices plunged. It was a vicious, self-perpetuating cycle that led to the greatest U.S. financial crisis since the Great Depression in the 1930s.

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Where Do We Stand?

Theoretically, interest rate hikes brought on by the Fed should boost U.S. savings. After all, higher interest rates mean investors earn more. “When you look historically at interest rates for borrowers, particularly when it comes to big ticket items such as car or home, the current interest rate environment is still much better than it was in past years,” said Talwar.

However, the weight of the country’s burgeoning debt and wealth inequality stifles the progress of the U.S. savings rate. We expect it to increase modestly over the next few years, but don’t plan for it to return to a double-digit level from 5.3 percent any time soon. The best thing to do to protect your money? “Shop around for the best interest rates, whether it’s a mortgage, credit card or your savings,” Talwar advised. “Consumers can and should be parking their money with a bank that is paying a competitive APY rate.”

Find Out Why: You Have a Higher Net Worth Than the U.S. Government

About the Author

Paul Meeks

In addition to being a financial journalist for decades, Paul has been an equity (stocks) analyst or portfolio manager at marquee firms. For Merrill Lynch Investment Managers (since acquired by BlackRock), he started and managed the world’s largest technology mutual funds franchise with $8 billion invested. Paul has taught Personal Finance and Investments courses since 2005.

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