What The Fed's Rate Hikes Will Mean For Your Finances

Loading...
Loading...

Rate Increases, at an Increasing Rate

After slashing interest rates to near zero as part of the biggest economic stimulus program since the Great Depression, it took the Federal Reserve seven years to raise interest rates again. It took the Fed another year to apply a second rate hike, and only three months for a third. As they accelerate restoration of more typical interest rates, the Fed has signaled two more rate hikes for the remainder of 2017 and three for 2018.

Are Fed interest rate hikes good news or bad news for you? There could be elements of both, depending on your overall financial situation.

It's important to note that the Fed Funds rate (what banks charge other banks for overnight borrowing) is still very low in historical terms. The average interest rate from 1971 through 2016 was 5.81 percent, and that includes seven years of near-zero rates. In March 1980, interest rates were a whopping 20 percent.

We are gradually returning to a more normal economy after 7 years of being stuck in neutral. The current rate hikes are small (in increments of 0.25% so far) to avoid spooking investors and stalling the economic recovery. However, even with incremental changes, effects from Fed rate hikes will cascade through to consumers.

Rate Hike Effects

It will cost banks more to borrow money from each other, and those costs will be passed on to you. That's true for personal loans as well as new mortgages. Existing fixed-rate mortgages are already locked in, but adjustable-rate mortgages (ARMs) are directly linked to the prime rate.

Credit card rates are likely to rise by the same logic. Credit card issuers are not obligated to notify customers of variable annual percentage rate (APR) increases, so be sure to check with your issuer to verify the effect on your rates.

What about stocks and bonds? The last few interest rate hikes show that a rate hike doesn't necessarily retard stocks. When interest rates are so low that investors can't make any reasonable money in bonds, equities are the only place to go. As rates rise, bonds will become more attractive and money should flow from stocks to bonds. Bond demand will rise, driving prices down and increasing yields.

Savings accounts and liquid investments such as money market accounts will yield more interest. That should benefit seniors who are relying more on fixed incomes and those with conservative portfolios.

Most student loans are not affected, because well over 90 percent of them are fixed-rate government loans. Variable rate loans are usually tied to the London Interbank Offered Rate (LIBOR), but LIBOR often tracks the federal funds rate.

How to Protect Yourself against Future Hikes

Loading...
Loading...

If you are in the home buying market, don't let these slow interest rate increases drive you into buying a home before you're ready to make the financial commitment. Rates are still relatively low. However, if you're ready to buy, it's wise to do so soon to save whatever money you can.

Refinancing a loan requires greater urgency. Refinancing only makes sense when there is a large enough difference in your current rate and new rates to cover closing costs and any other loan origination expenses—and rising rates close the refinancing window. You could open the window up again by improving your credit enough that you qualify for better relative interest rates.

Keep your credit cards under control to maintain a good credit score and get the best interest rate possible. If you have a variable-rate credit card, consider switching to a fixed-rate card and limit your credit purchases.

Regarding retirement accounts, stick with your original plan and don't overthink a modest interest rate change—although it may be worthwhile to review the investments behind your 401(k) and adjust them if they are not meeting your needs on returns within your risk tolerance.

The Takeaway

In general, rising interest rates mean bad news for borrowers, good news for savers, and mixed news for investors and retirees. You probably fall into at least two of those categories.

Remember all aspects of your finances as you assess the impact of an interest rate hike and follow these basic rules: Borrow wisely and only when you have to, refinance if it is to your advantage, check your retirement investments to see if they are still meeting your needs on risk and return, and spend within your budget to keep credit card expenses to a minimum. That's pretty sound advice regardless of interest rates.

This article was provided by our partners at moneytips.com.

To Read More From MoneyTips:

Joint Mortgage Could Cost You More

Poll: 57% Of Americans Think Trump Will Affect Their Retirement Strategy

Loading...
Loading...
Posted In: Personal Financecontributor
We simplify the market for smarter investing

Trade confidently with insights and alerts from analyst ratings, free reports and breaking news that affects the stocks you care about.

Join Now: Free!

Loading...