Interest rates are (finally) increasing. Now what?
The long-awaited interest rate hike by the Federal Reserve was finally announced in December. The Fed stated that it would raise rates by a quarter of a percentage point, the first increase since June 2006. The Fed’s statement emphasized that the state of the economy is not putting any pressure on it to raise rates again in the near term, and that if it does continue to increase the Fed Funds Rate target range, the increases will be measured and staggered. Inflation remains modest and the employment situation is stable. Over the last 12 months through November, the Consumer Price Index for all items increased 0.5 percent and the national unemployment rate was unchanged at 5 percent.
What steps should you take in reaction to rising rates?
A quarter point rate hike has a minor impact on the average household budget, and it is largely reflected in the financial markets already. For example, a family paying interest-only on a $300,000 home equity line of credit may owe $750 more interest over the course of a year, or only $62.50 more a month. Higher rates will mean different things to different investors, depending on age and financial situation. There are a few prudent things to review to better evaluate your situation and prepare should rates gradually climb back to higher levels.
Investments: Bond prices typically decline when rates rise, but income reinvested at higher rates can help offset that price depreciation. Bonds can still provide benefits to a well-diversified portfolio. They can often reduce portfolio volatility, and rates could still remain well below historic norms for a number of years. Long-term investors with appropriate diversification may be best served by ignoring the noise that market volatility brings.
Mortgages: If you recently locked into a fixed mortgage, rising rates should not concern you. There could still be an opportunity to refinance to a better fixed rate mortgage if your current mortgage is higher than market rates. Not more than 10 years ago, the average 30 year fixed-rate mortgage was over 6.0%, compared to just under 4% in 2015. Most adjustable mortgage rates are reset once per year. If rates rise a number of times, you could end up paying more in years to come. You may consider refinancing to a fixed rate loan before long-term rates increase if you are considering living in your current home for at least a few more years. Now may be a good time to review your variable loan terms, to make sure you understand how often the rate can rise, how much the rate can rise in one year, and what the maximum rate is on the life of the loan. If the terms are favorable, or if the loan will be paid off or substantially reduced in the near-term, there may not be an advantage to refinancing to a fixed rate.
Savings Accounts: Bank savings rates and money market yields are unlikely to move quickly. Banks do not immediately pass on higher savings rates to their depositors. However, savers should expect to benefit eventually.
Consumer Debt: Credit card rates are likely to rise almost immediately and at a faster rate than other types of debt. Credit agreements often require a 45 day notice for changes in terms, but a variable rate increase is an exception not subject to advance notice to the cardholder. Some cards have a rate ceiling, so a small increase may not change the APR for these borrowers. If you are considering a balance transfer, beware transfer fees and promotional rates that expire after 6 months. Financing a car is also likely to become more expensive as the Fed raises rates.
Student Loans: Federal student loan interest rates are set by Congress. This site has current rate information http://www.direct.ed.gov/calc.html. Rates for new loans are reset annually, but borrowers keep the rate they were given for the life of the loan. Students take out new loans each year, so they could be repaying several loans with different and incrementally higher rates. Private student loans from banks tend to be correlated with the Federal funds rate and one should expect refinancing or new loans to become gradually more costly.
Remain focused on your long-term goals.
Rising rates have been expected for some time, yet many investors without a long-term plan may make impulsive decisions as a result of the recent rate hike. At Heritage, we remind our clients that a disciplined process is essential to long-term investment success. We will continue to monitor the state of financial markets and adjust portfolio positioning when appropriate.