Economists predict the Federal Reserve will soon raise benchmark rates for the first time since the great financial meltdown of 2008-2009. Because of that crash the Fed held the benchmark, which guides bank rates charged on everything from mortgages to credit cards, at or near zero. But improving jobs, consumption and housing numbers encourage the Fed to ratchet up its guideline rates.
“It’s like the domino effect,” says Howard Dvorkin, author of Credit Hell: How to Dig Out of Debt and Power Up: Taking Charge of Your Financial Destiny. “The Fed is the first domino, and whatever it does creates the chain reaction. While the Fed does not have the ability to directly set mortgage rates, it does create the monetary policies that indirectly affect these rates.”
Here is a look at how the chain reaction can provide pain points for your financial health:
Rising credit card rates:
Most consumers today have credit cards with variable interest rates. If the Fed boosts its federal fund rate, this will cause interest rates throughout the economy to rise. Those variable rates on credit cards, then, will also increase.
This can have a negative impact on consumers who carry debt each month on their credit cards. With a higher rate, that credit card debt could rise.
Dvorkin recommends that consumers pay down as much of their credit card debt as possible before the Fed increases the federal funds rate. Ideally, you would never carry a balance on your credit cards from month to month.
More expensive to buy a home:
Mortgage interest rates have been at historic lows for years. As of mid-November, Freddie Mac reported that the average interest rate on a 30-year fixed-rate mortgage loan was still under 4 percent.
If the Fed raises the federal funds rate, expect mortgage interest rates to increase. But how much? No one knows that. But they will go up. And when they do, it will become more expensive for you to borrow mortgage money.
Say today you could qualify for a 30-year fixed-rate mortgage loan of $200,000 with an interest rate of 3.98 percent. Your monthly mortgage payment would be $952, not including what you pay for homeowners insurance and property taxes every month. If, after the Fed rate hike, you will now qualify for a $200,000 30-year fixed-rate loan with an interest rate of 4.5 percent, your mortgage payment would be $1,013 a month, not including taxes and insurance.
That’s an increase of $61 a month or $732 a year.
Ravi Madhwani, a mortgage loan officer and real estate agent in the San Fernando Valley region of California, says higher interest rates might also make it more difficult for some borrowers to qualify for a mortgage loan because they would need higher incomes as their monthly payments jump.
“This hurts the home buyers who are in the market looking,” Madhwani says.
Other loans more costly, too:
Rising rates would make all loans more expensive, including auto loans, personal loans and small business loans, says Bob Johnson, president and chief executive officer of The American College of Financial Services.
“Lenders will benefit, ” Bob Johnson says, “borrowers will be hurt.”
Putting the hurt on retirement savings?
Do you contribute to a 401(k) plan offered by your employer? Do you invest in an IRA? A Fed rate hike could slow the growth of your retirement accounts, Johnson said.
The stock market tends to perform poorly when interest rates rise, Johnson said. The book Invest With the Fed – which Johnson wrote with co-authors Gerald Jensen from Creighton University and Luis Garcia-Feijoo of Florida Atlantic University – found that the Standard & Poor’s 500 from 1966 through 2013 averaged an annual return of 15.2 percent when interest rates fell and 5.9 percent when they rose.
If rates rise, then, consumers can expect to see a poor-performing stock market, and if much of their retirement funds are invested in mutual funds connected to stocks? That could make opening those retirement-fund statements less enjoyable.
“Consumers invested in stocks won’t see their retirement accounts grow as rapidly when rates rise,” Bob Johnson says.
A bit of a boost to savings accounts and fixed-income investments?
Johnson says investors who put their money in new CDs, savings accounts, bonds and other fixed-income investments will benefit as the rates on newly issued debt will rise.
Those who hold money in traditional savings accounts might also benefit. The interest rates that banks have attached to savings accounts have been at historically low levels since 2008. The FDIC says that the national average interest rate on these savings vehicles was at 0.06 percent as of Nov. 16.
No one knows how much the average interest rate on savings accounts and CDs will rise after a Fed rate hike, but they will jump, at least by a bit.