FYAD: What Rising Interest Rates Mean for You

Last Wednesday, March 16th, the Federal Reserve raised its target federal funds rate by a quarter percentage point (0.25%) from near zero. The move was widely anticipated as a reaction to the historically high levels of inflation seen in recent months. For example, the consumer price index for February 2022 rose 7.9% from a year earlier – the biggest increase since January 1982.

This was the first increase in the benchmark rate in 3 years and will lay the foundation for an expected 6 more rate hikes by year’s end and likely 3 rate hikes in 2024. Ultimately bringing the fed funds rate up around 2.75%.

For those of you wondering, the fed funds rate is the interest rate at which banks borrow and lend money to one another overnight. Although that’s not the rate the everyday consumer pays, it does have an impact on the borrowing and savings rates we see every day. A quarter point rate hike from zero will have minimal impact on households, but the cumulative effect of multiple rate hikes will have an impact on the economy and personal finances. 

So how do these rate hikes impact you? 

Well,  that depends, are you a saver or a borrower?

A Win for the Saver

If you are the saver, the gradual rise of the fed funds rate is a welcomed change. When the economy fell into a recession in 2020, the Federal Reserve was forced to push interest rates to zero to revive the economy. While beneficial for the borrower, this greatly hindered the ability for the saver to earn any interest on money stashed in bank accounts, CDS, money market funds, and even high-grade debt. 

According to the data released by the Federal Deposit Insurance Corporation (FDIC), funds invested in a savings account average just 0.06% interest while a 12-month certificate of deposit (CD) yields just 0.14%.

While we do expect interest rates on these common savings instruments to tick up, don’t expect banks to rush and raise their savings rates tomorrow. Currently banks are sitting on mountains of deposits and don’t need to quickly raise rates to bring cash in. Because of this expect your savings to get a slight boost over the next 18-24 months. 

Although higher interest rates will benefit the saver long-term, the high levels of inflation are still greatly eroding the purchasing power of the money stashed at the bank. 

The Cost of Borrowing is Going Up

Unlike the saver who will start to see more favorable conditions, the opposite can be said for those who plan to borrow or have borrowed money through instruments tied to the Fed’s key rate, such as credit cards, some auto loans, adjustable-rate mortgages (ARMs) and home equity lines of credit (HELOCs). 

As the fed funds rate ticks up over the next 18 months you can expect to see the cost to service your debt tick up as well. 

We have already started to see fixed mortgage rates moving higher since they are impacted by the economy and inflation. 

The average 30-year fixed-rate home mortgage is now above 4% and is likely to keep climbing. 

What does this mean to your monthly budget – here’s an example courtesy of CNBC: 

• A $300,000, 30-year, fixed-rate mortgage would cost you about $1,432 a month at a 4% rate. If you paid 4.5% instead, then the same loan would cost $131 a month more or another $1,572 each year, and $47,160 over the loan’s lifetime.

If you are a homeowner with an adjustable-rate mortgage or home equity line of credit, which are both pegged to the prime rate, your cost to service your debt will go up. Most ARMs adjust once a year, while the HELOC rate will likely adjust immediately. 

Even though auto loans are fixed, payments are going up. Car loans are not only getting bigger because of rising interest rates but because car prices have skyrocketed as well. If you are planning to finance a car expect to shell out more money in the year ahead.

According to Experian, a car buyer who took out a loan for a new vehicle in 2021 borrowed an average of $39,721, an increase of over $4,000 from the year before! As a result, monthly loan payments hit a record $644 per month. This is only expected to rise as supply-chain issues will continue to keep car prices high and rising interest rates increase the cost to service the debt. 

Credit card borrowers will also be impacted within a billing cycle or two since most credit cards carry a variable rate with APR directly correlated to the Fed’s benchmark. Like most debt, a quarter point increase won’t likely flip your finances upside down but will have a longer-term impact as rates continue to rise. 

Advice for the Borrower

If you have used a variable-rate loan it may be time to consider refinancing to a fixed rate. This transition will allow you to manage your ability to pay down your debt.

Borrowers who have used credit cards may be able to call their card issuer and request a lower rate, switch to a zero-interest balance transfer credit card or consolidate high interest debt with a lower-interest personal loan.  

We trust you’ve found this article to be educational and helpful. If you have any questions or would like to discuss any matters, please feel free to give us or any of our team members a call.

As always, we’re honored and humbled that you have given us the opportunity to serve as your financial advisor.

Table 1: Key Index Returns

Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar

MTD returns: Jan 31, 2022—Feb 28, 2022

YTD returns: Dec 31, 2021—Feb 28, 2022

*In US dollars