How the Fed Interest Rate Hike Affects You

by James on December 15, 2016 · 0 comments

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The Federal Open Market Committee (FOMC) of the Federal Reserve recently raised its benchmark short-term interest rate by 0.25 percentage points. The recent rate increase is the second time the Fed has raised federal funds rate in over ten years. The first was in 2015.

Speaking about the rate hike, Fed chairwoman, Janet Yellen, said that the US economy had shown considerable progress over the past year to warrant the increase. According to her, with the progress in the US economy, the Fed could raise rates three times in 2017.

Being an important economic decision, it will affect you in some way. But how will it? Here’s a brief on that.

Stocks

Theoretically, an increase in federal funds rate affects stock via a ripple effect, which is unlikely to occur in the near-term. Fundamentally, an interest rate increase should be positive for stocks because it indicates the economy is growing. However, it could have indirect side effect over the long haul. A rate increase means that the cost borrowing funds from the Fed is now higher. This will make lenders (banks) increase the interest rates at which they lend out money to consumers.

Again, theoretically, higher rates for consumers could mean that they’d have less disposable income. This would make them spend less money, thereby, affecting the revenues and incomes of companies and possibly, future cash flow. Moreover, since businesses are also going to get loans at higher cost, profitability goes under threat. This isn’t positive for stocks.

However, the truth about this is that this only happens after a long period, after which the rate increase has helped stabilize economy, but then becomes unsustainable. Therefore, in the near term, the rate hike is unlikely to affect the economy negatively. Moreover, if you’re a long-term investor, which you should be, Fed’s economic decisions should have minimal impact on your investing principles. If anything, you should only find the opportunities its decisions present.

Mortgages

The US 30-Year fixed mortgage rate has increased by roughly a half percentage point, to approximately 4.1% since the election. This can be partly traced down to statements by president-elect Trump about how the then-current federal funds rate was too low during his campaign trial.

So yes, the latest rate hike is likely to make the cost of buying a new home higher. Still, though, the latest rate hike still puts current rates around historical lows. It’s only in expensive locations that the rate increase could significantly affect mortgages.

However, if the Fed eventually raises federal funds rate thrice in 2017, the costs of buying a new home could be significantly higher across board. Folks with variable-rate mortgage should also watch closely, as the impact could start as soon as now.

Auto Loans

Obviously, the rate hike is going to increase rates on auto loan for new buyers as well. You don’t have to worry if what you have on your auto is a fixed-rate loan. A rate hike won’t affect it. One thing to note, though, is that a rate hike doesn’t affect auto loans as much as mortgages simply because mortgages are usually larger than auto loans. In addition, the terms on auto loans are usually significantly shorter than mortgages

The average price of a new car was $33,666 as of march 2016, according to Kelly Blue Book. On the other hand, the median sales price of new houses in the US was $304,500 as of October 2016, according to Federal Reserve Bank of St. Louis.

A 0.5% increase on a $300,000, 30-year fixed mortgage adds $45,000 over the lifetime of the mortgage. However, a 0.5% increase on a $33,000, 67-month auto loan adds only about $14 monthly. For reference, the monthly increase of the mortgage is $125.

Long story short, this rate hike is unlikely to cause huge upset for prospective car buyers. Again, as rates get higher in 2017, you need to be watchful. It might help to take action as soon as possible in order to lock in lower rates.

Credit Cards

Folks with variable-rate credit cards are likely to feel the rate hike more quickly. According to CreditCards.com, the national average credit card interest rate was 15.18%, as of December 15, 2016. Because of the structure of this class of debt, banks will effect the 0.25%-point increase in funds rate over the next few weeks. Since credit card rates are already high, any little increase in rate should be taken seriously.

Moreover, the rate hike could have bigger adverse effect on those with bad credit loans, considering that the average credit card interest rate for bad credit stands at around 23%. The best decision would be to pay off the debt as soon as possible or get in to a fix-rate arrangement.

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