Here’s how interest rate hikes impact your money
It’s an announcement that makes many people shudder.
The Federal Reserve raised interest rates twice this year and Fed Chairman Jerome Powell has indicated that two more increases could be on the way, which could have an indirect impact on the prices you pay at when you fill up your car, get groceries or go out to dinner.
“Interest rate hikes trickle down to consumer spending habits,” says Joel Johnson, FirstBank’s president for the East Valley. “When the Fed decreases rates, the goal is to get people to spend more. When the Fed increases rates, the opposite happens. Folks spend less since they have less disposable income and more money is going towards interest, and that can have a ripple effect on local businesses and retailers. The positive thing about higher rates is they can help slow inflation, normalize or bring down costs and provide consumers with higher credit deposit rates, enabling them to save more.”
Here’s the underlying good news about the rate increases, according to Matt Gilbreath, senior vice president and regional manager at Alliance Bank: the Fed’s increases are due to the strength of the economy – unemployment is at historic lows and most sectors are enjoying strong growth and earnings. The Fed has indicated they will increase rates from historic lows back to something a bit more normal due to the economy not only regaining its footing, but really heating up.
“This is a balancing act for the Fed as they don’t want to raise rates too fast or too high that it has a negative effect,” Gilbreath says, “but they do want to keep a lid on inflation and get things back to a level that’s in line with a strong economy.”
While the Fed’s moves show confidence in the economy, many consumers are still left to ask, “how will these interest rate hikes impact my money?”
“There is good news and not-so-good news for consumers,” says Kim Dees, senior vice president and Southern Arizona retail division manager for Washington Federal. “The good news is those working to build their savings will see higher rates, which will help achieve those savings goals. The other side of the rate hikes for consumers is the cost of borrowing funds is rising.”
While there have been noticeable increases in interest rates, Gilbreath says it’s important to remember that rates are still at historic lows.
“With that being said, consumers will feel the effects through rising interest rates for mortgage loans and car loans,” Gilbreath says. “Floating rate loans such as credit cards or home equity loans will go up as well.”
Impact so far
According to Anthony Chan, Chase’s managing director and chief economist, we are starting to see some of the impact of the interest rate increases, but it’s not hurting the robust economy.
• Due to tax cuts and U.S. employment growth — the U.S. unemployment is at just 4 percent — there hasn’t been a plunge in mortgage originations, even as the Fed has raised its policy rates.
• New car interest rates have risen in line with the increase in the Fed’s rates, which may explain some slowdown in car sales, but the upward move in the Fed’s policy rates have not hurt U.S. car sales in a material fashion.
• Despite higher credit card rates, U.S. consumer spending remains robust as evidenced by the 4 percent growth rate in the second quarter of 2018.
But banks are seeing some impact.
“Refinance activity is dropping off significantly as rates move higher,” says Sean McCarthy, regional chief investment officer for Wells Fargo Private Bank. “The June forecast from the Mortgage Bankers Association sees the 30-year mortgage rate reaching 5 percent either later this year or early next year. They still expect the volume of mortgage originations for purchases to be around 5 percent higher for all of 2018. Conversely, refi volume is expected to be more than 20 percent lower than last year.”
Isaac M. Gabriel, a partner at Quarles & Brady in Phoenix, explains that while mortgage lending rates are not set by the Fed, mortgage rates often rise as the Fed raises rates.
“When mortgage rates rise, mortgage payments simply become more expensive,” Gabriel says.
For example, a $300,000, 30-year mortgage, with a 4 percent interest rate would have a monthly payment of $1,432. If the rate rises to 5 percent, the payment increases to $1,610, a difference of $178 per month.
“The end result is individuals may not be able to afford a larger mortgage loan,” Gabriel says. “Similarly, individuals with adjustable rate mortgages (ARMs) will see their mortgage payments increase as a result of any increase on the mortgage lending rates. Increased rates can also put downward pressure on home prices, due to the fact that buyers cannot afford the same amount of debt due to the higher rates.”
The impact of the Fed’s actions isn’t only felt by consumers. The impact of interest rate hikes on businesses is similar to the impact on consumers.
“For new loans, interest rates have noticeably risen over the last year, but they are still at historic lows,” Gilbreath says. “If businesses have floating rate debt, they will see an increase in interest expense and also an increase in interest earned on savings.”
Managing rate increases
So what should consumers do to reduce the impact of interest rate hikes in the future?
“Borrow less and pay down faster,” says Douglas W. Cole, director of investment management at Wilde Wealth Management Group. “That might not be an option for some. Where possible, transfer credit card balances to lower rate cards.”
For balance transfers, Cole says a good strategy is to review options for new cards that use zero-percent interest as a teaser. He says to also look at possibilities for fixed-rate, fixed-term alternatives to refinance debt. Lending Tree and Goldman Sachs’ “Marcus” are two alternatives.
“Consumers should focus on eliminating their debt and work to pay off those credit card balances on a monthly basis,” Dees says. “Not having to pay all that interest will be a huge savings in the long term. In turn, take advantage of the higher savings rates. This boost in rates will help achieve your savings goals.”
Chan says consumers should keep in mind that the Fed has said it views the neutral policy rate — the rate at which real Gross Domestic Product is growing at its trend rate and inflation is stable — around 2.9 percent and appears to be signaling that it may overshoot that rate by as much as 0.5 percent.
“As a result, a typical consumer that has outstanding loans with variable rates should estimate the burden of this debt at this higher rate,” Chan says. “If the burden of the rate is too much, they should strive to pay off some of this debt. But if the monthly payments with the higher rate are still not likely to have a material negative impact, then they could relax a bit.”
Here’s the bottom line, according to experts: The healthy economy should offset the hurt that might otherwise be felt from the Fed’s hikes.
“Consumer buying power will be impacted, but that should be offset by better wages and a healthy job market,” Johnson says. “So don’t panic. This is a built-in mechanism to maintain equilibrium. Rates will go up, recessions will hit, rates will go down and life will go on. Control the controllable and be prepared for anything.”