Fed rate hike: Are you a winner or a loser?
In what is becoming an annual tradition, the Federal Reserve hiked a key short-term interest rate during the central bank’s December meeting.
This advanced the trend that the Fed established three years ago, when it raised rates for the first time in a decade as the economy began to pick up steam. Since then, the U.S. unemployment rate has continued to fall while the stock market keeps notching all-time highs. Inflation and earnings growth, though, remain less than stellar.
A world of higher interest rates means different things to different people, depending on whether you’re a borrower or lender. Homebuyers, homeowners with equity, credit card holders, vehicle owners making car payments and savers will all react somewhat differently to this news.
Here’s what you need to know.
Mortgage rates depend largely on the 10-year Treasury yield rather than the federal funds rate. But investor demand for government debt and the rationale behind the Fed’s decisions often dovetail.
Animal spirits have perked up a bit over the last few months. Corporate earnings remain strong, the economy continues to convalesce and market participants believe that the GOP tax plan will lead to more economic growth. That has put a limit on bond prices as folks switch over to stocks (remember, bond prices and yields are inversely related.)
The Fed agrees, believing that the economy can withstand higher borrowing costs. Rates for a 30-year fixed mortgage have moved up over the past six months to above 4 percent.
Homeowners who locked in a fixed-rate mortgages over the summer are winners because mortgage rates have since ticked up.
If the GOP tax bill passes, and investors buy into an American growth narrative, mortgage rates should continue to rise. Nevertheless, rates almost certainly will remain low by historical standards, so people who shop successfully for a mortgage this year can count themselves as winners. Remember, the 30-year fixed averaged 6.74 percent six months before the Great Recession began.
Homeowners with adjustable-rate mortgages (ARMs), might end up with bigger payments when the next rate adjustment rolls around. ARMs are tied to indexes that are sensitive to Fed rate moves.
Using your home as a credit card? Get ready for your fifth rate increase since December 2015 and the third hike this year. Comparison-shop home equity lines so you can get cash to pay for home renovations or other financial needs.
Rates on home equity lines of credit, or HELOCs, will rise a quarter of a percentage point. Expect it to hit your wallet within 30 days, or by the second billing statement after the Fed’s hike. Virtually all HELOCs are linked to the prime rate. The Fed’s action immediately raises the prime rate by one-quarter of a percentage point, to 4.50 percent.
Many HELOCs have a feature that lets you set aside a portion of the amount you borrow, take a fixed rate on that and then pay it down. Those fixed rates won’t change. Alternatively, if you have a fixed-rate home equity loan, your interest rate won’t change.
Many variable-rate credit cards are tied to movement in the prime rate, which is tied to the Fed’s federal funds rate. When that goes up, your credit card’s annual percentage rate is likely to rise as well.
“Only if you carry a balance is this really going to be an issue,” says Eric Lindeen, vice president of marketing at ID Analytics, a risk management firm.
The added revenue from credit card interest could ultimately allow financial institutions to reintroduce more competitive deposit products. In other words, “the biggest winners are going to be those that are saving rather than borrowing,” Lindeen says.
If you need to carry balances month-to-month, find a low-rate credit card today.
If you’re carrying a balance on a variable-rate card, “it’s time to hustle up and get (debts) paid down,” says Greg McBride, CFA, senior vice president and chief financial analyst at Bankrate.
Shop now for the best balance transfer cards before credit cards with 0 percent interest rate offers become scarcer.
CDs and money market accounts
Savers might wonder when savings rates will finally return to something resembling normal. The most likely answer: not soon.
In addition to this quarter-point hike, savers can look forward to another three increases in 2018, if all goes to plan. That would make it more attractive to shop for high-yield certificates of deposit.
But this takes time. “Fed rate hikes typically mean some increase in interest rates on savings accounts and CDs,” says Don Kohn, a former Fed vice chairman and now a senior fellow at the Brookings Institution.
“At least some of it will get passed through in deposit rates, with a lag,” Kohn says.
Your cash still isn’t doing much for you, and the Fed will be deliberate as it raises rates to pre-recession levels.
If you bit the bullet and opened a multi-year CD recently and it wasn’t a rising-rate CD, you’re going to have to grit your teeth and accept a lower rate until it matures, or risk paying a potentially hefty early withdrawal penalty.
The Fed’s action will tap the accelerator on auto loan interest rates, though they’re not likely to rise too much.
Auto loan rates don’t move in lockstep with interest rates set by the Fed, but they do follow the trend set by the central bank—and rates have moved up since last summer.
Interest rate rises will be gradual but unstoppable, so the sooner you get an auto loan, the better.
Shopping around for car loans and improving your credit rating can win a great rate, no matter what the Fed does.
“A couple of quarter-point rate moves by the Fed are small potatoes by comparison,” says Bankrate’s McBride. “A rate hike has virtually zero impact on auto loan affordability, with a quarter-point hike meaning a difference of $3 in monthly payment. Nobody will have to downsize from the SUV to the compact based on rising interest rates.”
Let this move be a reminder to not buy more car than you can afford.