Update 03/15/2017: The Fed has announced a quarter point increase as expected.
For almost 10 years, while our economy has been struggling to recover from the recession, one thing that has been a big plus and important to people has been the historic lows in interest rates, but that may be about to change. While the job market was down, the stock market was down, and the emotions of the American people were down, interest rates were adjusted so that many people were still able to afford to buy a home and use their credit cards. But, the Federal Reserve Board (a.k.a. the Fed) raised interest rates last December for just the second time in the last 10 years. That may be the beginning of a huge change over the next couple of years, and that begs a lot of questions.
What a Fed Interest Rate Hike Could Mean
1. How certain is a rise in interest rates?
There is little doubt that interest rates will go up again, beginning this coming week. On Wednesday, March 15th the Fed is expected to announce just that. It’s a move that was almost guaranteed by the good news about the job reports released last week, increases of 235,000 jobs and the drop of the unemployment rate to a low 4.7%. There was also good news about wage growth that further indicates the recovery is moving along at a much better rate than before.
A bigger question is how many more increases are coming and how fast will they occur? According to the Fed chair, Janet Yellen, raising rates too slowly may not be good for the economy and raising them too quickly could send the economy back into a recession.
Having said that, it does seem we can expect multiple increases this year and again next year as the inflation rate moves up towards the Fed goal of 2.0%, jobs continue to grow (76 consecutive months as of now), and the Trump Plan tax cuts are instituted. Business is projected to improve on the speculation that President Trump plans to expand the rebuilding of the infrastructure and increase military spending. That effect on our economy is all projected as a positive. It does remain uncertain though (there is always a “but”), as this is all dependent on the passage of the President’s plan which is never a certainty.
2. What might happen to your credit card interest rate?
Most credit card rates are fixed but you can expect that when there is a rise in interest rates from the Fed, your credit card rate will follow in step. Within 60 days you can expect to see a notice from your card provider telling you just that and they must give you a 45 day notice before the new higher rates go into effect. This period of time gives you the chance to consolidate your debt, even taking advantage of the many low fee current offers of “0%” interest for as long as 21 months that can help keep your debt interest under control.
FYI if your credit card has a variable interest rate, that rate can be raised immediately if Fed rates go up.
3. What might happen to mortgage rates?
There is some uncertainty as to what might happen to mortgage rates when the Fed rate goes up. Last December, after the 0.25% rate increase, mortgage rates for a 30 year mortgage rose to an average of 4.2% which was the highest rate in over 2½ years.
Because 10 year treasury bonds are used to set mortgage rates, a Fed rate increase might cause those rates to increase. The question is whether inflation will remain on their target, otherwise that will cause fixed rates to increase. You can be sure, however, that adjustable rate mortgages will go up and that home equity lines of credit (HELOCs) will also be increased (within 3 months) when the Fed rate rises.
If you are considering a new mortgage, think about a fixed rate mortgage. An alternative is a 5 year ARM (adjustable rate mortgage for 5 years fixed) to lock in the rate for a bit longer time rather than take any chances.
4. Auto loans – where will they be going?
Auto sales set a record in 2016 and if the Fed increase is just a small one, you probably won’t see any change in auto loan rates. Dealers want to keep this trend moving along and will want to keep incentives and low rates. Economic success and car sales are linked and making auto loan rates higher may discourage sales. However, if the Fed raises rates 3 or 4 times this year and/or next, those rates will increase. It’s uncertain right now as to what will happen, but it’s wise to consider what your needs are and how a rise in rates will affect you.
5. Will your student loan payments increase?
If your student loan was begun after 2006, it is a fixed rate loan and won’t change your payments in any way. Before that, there were some variable rate loans (Stafford loans) and they could be changed if they haven’t as of yet been paid off. Check your loan documents if you are in that situation. You can consider a refinance, but don’t be too crazed; one Fed hike isn’t going to create havoc with your repayment plan.
6. What might happen to your retirement plan accounts?
Higher interest rates can have an impact on your retirement plan. It’s complex because there are many factors that influence your money such as its diversification and your target retirement date. It’s a fact that stocks and bonds become a bit volatile after any Fed increase in rates, but how it will affect you specifically will depend on the breakdown of your investments. If you haven’t done so recently, this might be a good time to seek a professional’s help to make sure that you are allocating your assets properly to prevent any kind of dramatic swings caused by rate increases.
7. What about my savings and CD accounts?
Don’t get too excited in thinking that you will be earning more money when the Fed raises interest rates. The interest rate increases you get on any savings and CDs are always much slower to react than borrowing rates. The rate increase last December hasn’t resulted in any noticeable changes in the bank rates paid to its customers. It may happen to go up, but it takes time and some patience. One way to maximize your rates is to shop around and strongly consider online banks which have been paying much higher rates to its customers for years now. While a half point isn’t a lot, why settle for rates like 0.01% on your savings account when you can get 0.75% or even 1.0% somewhere else?
8. What about the bond market?
When interest rates go up, bond values fall. That’s a fact. But don’t overreact. Bonds are not as volatile as stocks and can provide some stability in your investment portfolio. One change to consider is to stick with shorter term bonds that are less sensitive to interest rate changes.
The Bottom Line
We are certain to know more after the Fed meeting ends tomorrow. The clues about future rate hikes after the almost certain one that will be announced on March 15 will give us all a “heads up” as to what will happen down the road. Don’t be surprised if the stock markets react dramatically to any announcements that are made as that has come to happen even if there is a whisper of change. Just be aware of what is going on so you can make any adjustments in your personal finances if you need to do so.
Are you following the markets and what might happen if President Trump’s economic plans roll out as he wishes? How are you feeling about the recovery from the recession and have you benefited in that recovery? What are your biggest concerns about the economic future for you, your family, and our country?