Your Savings Account Probably Raised Its APY. Here's Why That's Not Good News

How could earning more interest be bad news?

If you have a savings account, chances are good you've been notified recently that your interest rate was going up. But don't get too excited if that happened to you.

It's actually bad news that rates are going up so much right now -- and you probably won't end up in a better financial position than before even if you earn higher returns on your saved funds.

Here's why.

There's a reason your bank has raised your rates

To understand why it is bad news that your savings account yield has gone up, it's helpful to know why this is happening with so many financial institutions.

Banks are raising rates for a simple reason. The Federal Reserve has raised interest rates. The central bank sets the benchmark rate and controls how much it costs for banks to borrow money overnight from other financial institutions.

The Federal Reserve had kept rates very low to stimulate the economy during the COVID-19 pandemic. But it has raised rates several times recently because of surging inflation. And further rate increases are expected.

The Federal Reserve doesn't control the interest rates on savings accounts directly. But when it raises rates, this has ripple effects throughout the economy.

Financial institutions generally need to begin charging higher rates on loans since the banks themselves are paying more to borrow. They also must compete to attract more deposits so they can make more loans at the current higher rates. They do this by offering higher returns to investors who put money into savings.

This is why you may get a notice from your bank that your rate has risen.

Why is this bad news for consumers?

This is bad news for many people for a few reasons.

First, your debt is also likely going to get more expensive due to the Federal Reserve raising rates. The higher rates will affect any variable rate loans, such as car loans or credit cards, and any loans you take out in the near future.

Unless you have a lot of savings and owe little or nothing, the added cost you're going to have to pay to creditors will probably dwarf any extra returns you get from savings.

The fact that the Federal Reserve is aggressively raising interest rates should also be a concern for everyone -- even those who don't have debt. It's happening because the Fed is worried about persistent inflation.

Inflation refers to the increasing costs of goods and services. It's inevitable, but the Federal Reserve's target rate of inflation is around 2% and we're way above that right now. Inflation has surged to a 40-year high and the Consumer Price Index rose 9.1% in June, which means the price of goods and services is close to 10% higher than it was last year.

While your savings account may be paying you a little extra, this isn't going to do much good in terms of helping your finances if you're paying almost 10% more for the things you buy.

Unfortunately, there's nothing you can do about the realities of high inflation. And you want to keep saving enough to cover any emergencies or surprise costs that occur. But you should be aware an increase in your savings account rate could be happening because of economic trouble on the horizon, and you should start taking steps to prepare for that possibility.