What does the interest rate increase mean for you?
What does the interest rate increase mean for you?
By: Stacey Nickens
This past St. Patrick’s Day, your pot of gold may have felt a bit emptier than usual. Between the higher cost of living and market volatility, your savings might be taking a hit. The Fed does recognize these inflationary concerns, and during their March meeting, they did take steps to try to tamp down the rising cost of living.
Fed officials voted to raise the benchmark federal funds rate by a quarter percentage. The benchmark rate will now be between 0.25% to 0.5%. The federal funds rate is the bank-to-bank lending rate, and when banks experience an increase in the cost of borrowing, they pass that increased cost onto consumers in the form of higher loan interest rates. These higher interest rates discourage consumers from opening lines of credit. As fewer consumers borrow to buy, demand for goods and inflation decline.
How will the increasing interest rates impact different forms of debt?
- Mortgage rates will likely increase. Mortgage rates track the yield on 10-year Treasury bonds, and these yields are impacted by the federal funds rate. If you are anticipating buying a house this year, you can follow these steps for locking in a lower mortgage interest rate. You should also know that other home loans, such as home equity lines, are more directly impacted by an increase to the federal funds rate. Home equity loan rates are thus likely to increase at a quicker pace.
- Credit card rates will probably increase in one or two statement cycles. You can prepare for this increase by moving a high-interest credit debt balance to another card that offers one year with 0% interest. This is known as a zero percent balance transfer. The transfer could give you up to a year to reduce your debt while also not making higher interest payments.
- Federal student loans carry a fixed rate set by the government and will not be impacted by the federal funds rate increase. However, private student loans will be impacted. Variable private loans will likely increase first, and when private borrowers price new fixed-rate loans, borrowers will likely face higher interest rates.
- Car loan rates will increase as a result of the federal fund rate hike, but this increase is unlikely to significantly impact monthly payments. Car loan rates track five-year Treasury securities, which are influenced by the federal funds rate. However, car loan rates are also influenced by a variety of factors, including credit history, and by the time rate increases are priced into your car loan, you may only see your loan amount increase by a few dollars each month.
- Yields on savings accounts, C.D.s, and money market funds will likely increase but still remain relatively low. An increase to the federal funds rate may encourage banks to increase their reserves. In turn, banks may increase their bank account yields to encourage customers to increase their deposits. However, larger banks already have fairly high reserves and don’t necessarily need to increase yields to incentivize deposits. On the other hand, smaller and online banks are more likely to increase yields to incentivize deposits. Certificates of deposit, or C.D.s, usually track Treasury securities and have already begun to modestly increase in response to the rate hike. Money market funds will likely also see higher yields.
- In the short-term, stocks respond to rate increases in more unpredictable ways. The increased cost of borrowing will increase the cost of doing business. However, analysts believe that the stock market has already priced in the impact of any potential rate hikes on a company’s value. Overall, I continue to encourage you to retain holdings in healthy companies for the long-term. You may consider looking at companies with large free cash flows, as these companies will be best situated to manage increased interest rates. Some companies with large free cash flows include Microsoft, Mastercard, and Lockheed Martin. You can use free online stock screeners to find other companies with large free cash flows.
- Bond valuations are very sensitive to interest rate hikes. Because newer bonds will have higher interest rates, the value of older bonds with lower yields will decline. If you are nervous about seeing your bond portfolio impacted by declining bond valuations, consider investing in preferred stocks and dividend-paying stocks. Both offer consistent income that could replace bond income in your portfolio. You can use dividendinvestor.com or preferredstockchannel.com to screen for income stocks.
Overall, interest rate hikes could increase your borrowing costs, but if they also tamp down inflation, your other expenses may decline. You can best prepare for higher interest rates by improving your credit report, such that you can qualify for the lowest possible interest rates on any new loans, and by ensuring your savings are invested in long-term, healthy securities.
