Higher interest rates now seem almost certain, with the Federal Reserve expected to make the first of several hikes beginning next month. And if you are shopping for a house, have an adjustable rate mortgage, or carry credit card debt, it will impact you.
Last week, the chairman of the central bank said he expected an increase of one-quarter of a percentage point in the “federal funds interest rate,” the Fed’s benchmark short-term interest rate, which has been near zero since the beginning of the pandemic.
Two other increases of the same size are expected later this year, for a total increase of three-quarters of a percentage point. It’s part of a strategy aimed at tamping down inflation, which is now running at 7 percent annually, the highest rate in 40 years.
An increase in the federal funds interest rate will make it more expensive for banks, credit unions, and other lenders to borrow money, and lenders are likely to pass along most if not all of that additional expense to consumers.
Here’s what you need to know:
Q. Will a change in interest rates mean a higher rate on my existing mortgage?
A. It depends on whether you have a fixed-rate or adjustable-rate mortgage (ARM). If your mortgage is fixed, then your interest rate won’t change. It’s locked in under the terms of your mortgage for as long as you have it.
If you have an ARM, you may face a higher interest rate. An ARM allows a borrower to lock in an interest rate that is usually lower than fixed rates, but only for a set period of time. When that period ends, the interest rate resets, usually to a rate based on an index such as the prime interest rate, which moves up or down in tandem with the federal funds rate. If your ARM resets at a time when interest rates are higher, as appears likely this year, you may pay more in interest costs. The most popular ARMs reset after five years, and then every year after that.
Q. What would a higher interest rate mean for someone shopping for a house or condo?
A. If interest rates go up, buying a house or condo will be more expensive. The sale price of the property and the amount you borrow may not change, but monthly interest charges will go up.
Q. How much more would it cost?
A. If the Fed lifts interest rates by three-quarters of a percentage point it may cost borrowers more than $130 a month in additional in interest, based on a $300,000, 30-year loan. That would add more than $45,000 in interest payments over 30 years.
Q. How much of my monthly budget should go to paying my mortgage?
A. Financial advisors usually recommend that you spend no more than 28 percent of your monthly gross income on your mortgage payment, including principal, interest, taxes, and insurance. If your interest costs go up $130 a month, you may have to check if you are still within the 28 percent benchmark. Here’s the Consumer Financial Protection Bureau’s guidance: https://www.consumerfinance.gov/owning-a-home/explore-rates/
Q. What about refinancing my mortgage?
A. The goal of paying off your existing mortgage with a new mortgage is usually a lower interest rate, and thus a lower monthly payment. Refinancing is very popular in times of declining interest rates, and slows when interest rates are rising. Check with lenders to see if it make sense to refinance now before interest rates go up.
Q. What about credit cards?
A. An increase in credit card interest rates seems very likely. Most issuers of credit cards use a variable annual percentage rate (APR) on any balance you may carry. Check your monthly statement for an explanation. My credit card company says it charges me “prime + margin.” “Prime” is the lowest rate banks charge their highest quality customers, including other banks. It fluctuates with the federal funds rates. “Margin” is the number of percentage points the credit card company charges over the prime, usually based on such things as your credit worthiness.
Q. So I will pay more interest on credit card debt?
A. Probably. But credit card companies must give you notice before hiking their interest rates, usually on the monthly statement. My credit card company limits changes in interest rates to once every three months. Now is the time to pay down some of your debt before the APR ticks up, if possible. And, remember, you can always call and ask for a lower rate. You may get it if your credit card company thinks you may take your debt to a competitor.
CreditCards.com predicts the average credit card interest rate will approach 17 percent by the end of the year, up from its current 16.13 percent.
Also take advantage of zero percent interest deals. If you have more than one credit card and one of them is offering zero percent interest, you can transfer your balance from a higher-interest card to one with zero interest, often for a year or more. That way you can pay down your balance without paying any interest. There are fees to take advantage of zero percent deals, though.
Q. What about automobile loans?
A. Auto loans will likely drift upward this year, but maybe not as much as other types of borrowing. One reason is the fierce competition among auto dealerships due to lingering supply chain issues. A much bigger issue for consumers may be the high cost of both new and used cars and trucks due to inflation.
Q. What about student loans?
A. Rising interest rates won’t impact existing fixed-rate private student loans, but probably will drive up rates on variable-rate loans and new loans. If you are thinking about refinancing your private student loan, now may be the time to investigate, before higher rates go into effect.
Federal student loans are fixed, and not subject to rate increases. The interest rate on new federal student loans, however, is expected to go up when the annual reset occurs on July 1.
Q. Are there any advantages to higher interest rates for consumers?
A. Yes, savings rates should go up slightly on bank certificates of deposits (CDs), money market accounts, and regular savings accounts.