How Rising Interest Rates Will Affect You
By Myles Ma
Interest rates have been creeping up slowly since 2015. But what does that mean for consumers?
The process by which rates go up and down is somewhat complicated. To begin with, the Federal Reserve, the central bank of the United States, targets an interest rate that promotes employment and stable prices for the country.
After the financial crisis of 2008, the Federal Reserve pushed the federal funds rate close to zero to help promote economic activity and hiring. (The federal funds rate is the interest rate banks use when they lend to one another.)
Banks also use the federal funds rate as a basis for interest rates on loans, credit cards, savings accounts and many other financial products. In general, when the federal funds rate goes up or down, other interest rates follow.
While interest rates have been historically low since 2008, the Fed began raising them again in 2015. The federal funds rate has gone from near zero to its current target of 0.75% to 1%.
Because so many rates are based on the federal funds rate, a rising federal funds rate could have broad implications for people’s finances. Here's a look at a few of the areas where rising rates could make a difference.
If you have a credit card, take a look at the terms and conditions, specifically the APR. After the numbers, there should be a disclaimer that reads something like, "This APR is based on your creditworthiness and will vary with the market based on the Prime Rate." That means as the Prime Rate moves, so will your card's APR. The Prime Rate is based on the federal funds rate.
"Any interest rate increase generally means that an individual's credit card rate will go up," said Aaron Aggerwal, assistant vice president of credit cards for Navy Federal Credit Union.
But consumers shouldn’t panic. The last rate increase was 0.25%, which on a $2,500 balance represents less than a dollar more in interest payments per month. That shouldn't set you back too much if you're paying down a balance, Aggerwal said. For people who pay down their balance each month and avoid interest rate charges, rising rates won't be an issue.
For anyone worried about their APRs rising, Aggerwal recommended looking into credit card balance transfer offers. These cards allow you to transfer your credit card balance at a 0% introductory APR. The introductory rate usually lasts at least a few months, allowing holders to pay down balances without worrying about interest charges.
Rates will also affect home loans. Anyone who plans to refinance their mortgage, borrow against their home with a home equity line of credit (HELOC) or get a new mortgage should act sooner rather than later, said Ray Rodriguez, a regional mortgage sales manager for TD Bank. However, Rodriguez advised against doing anything rash like making those moves before you’re financially ready or have done your research. "The sky is not falling," he said.
Mortgage rates remain at historically low levels, so buying a home is still a relatively good deal, he added. "We had some very fortunate times where interest rates were abnormally low, and we're getting back to the norm.”
The stock market generally doesn't perform as well when interest rates are rising, said Robert R. Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pennsylvania. Johnson co-authored "Invest With the Fed" with Gerald Jensen and Luis Garcia-Feijoo, which found that from 1966 to 2013, the S&P 500, a stock market index, gained 15.2% during times when rates were falling and 5.9% when rates were rising.
Like Rodriguez, Johnson cautioned against making drastic changes to your investments. "Trying to bank on the future path of interest rates is problematic," he said. "You want to be cautious."
Not all stocks suffer equally when interest rates rise. The authors of Invest With the Fed found that energy, consumer goods, utilities and food industries performed relatively well, while auto, durable goods, retail and apparel industries struggled.
The Fed is widely expected to raise interest rates later this year based on the steady improvement of the economy, according to the CME Group's FedWatch tool. However, a number of things could buck that expectation, say, if the U.S. goes to war, France leaves the European Union or any number of worldwide shocks upset the Fed's thinking on the economy.
So while interest rates can affect your finances, it's best not to make money moves based on how you or the market thinks they will move. "Oftentimes, we overestimate our ability to predict the path of interest rates," Johnson said.