With inflation running at the hottestWall Street is bracing for the possibility of interest rates rising even higher than previously expected.
Economists now see a two-thirds probability that the Fed will increase interest rates by a full percentage point at its meeting later this month, on July 26-27. That would be the steepest increase since the 1980s, coming afterlast month that was the sharpest increase since 1994.
“The Fed is likely going to send a hawkish message at the July meeting, and it would be a mistake to think that a rate hike less than 75 basis points is in the cards,” Charlie Ripley, senior investment strategist at Allianz Investment Management, said in a note this week. “The question that remains from here is how high the Fed will have to raise rates to bring down inflation.”
Here’s how the rate hike can affect your money — and how to prepare.
How much will the hike raise borrowing costs?
Every 0.25 percentage point increase in the Fed’s benchmark interest rate translates to an extra $25 a year in interest on $10,000 in debt.
So, if rates go up a full percentage, that $10,000 in credit-card debt becomes more expensive by $100 a year.
However, the Fed won’t be done raising rates in July. The committee’s projections show the key interest rate will be at 3.4% by the end of the year — or 1.8 percentage points higher than its current level. That means the same $10,000 in debt would cost $180 more to carry at year’s end.
What kinds of debt are affected?
The Fed’s short-term rates affect variable-rate debt. That means credit cards, home equity lines of credit, adjustable-rate mortgages and auto loans. Consumers with credit cards are advised toas much as possible.
“If you’re carrying balances on your credit cards, while at the same time keeping savings in bank or money market accounts at low interest rates, pay off or pay down your credit card balances to the degree you can,” said Susan Carlisle, a CPA based in Los Angeles.
The same goes for store credit-card lines, including lines of credit from Macy’s, Walmart and Target, Carlisle noted.
“The large Retailers have encouraged people to use their credit as an alternative way for them to earn revenues and profits, so those will be going up as well,” she said.
What about mortgage rates?
Interest rates on adjustable-rate mortgages are expected to keep rising for as long as the Fed increases rates. Most ARMs adjust their interest rate annually, so homeowners with ARMs that haven’t been adjusted yet in 2022 can soon expect to see much higher rates.
Carlisle advised homeowners with these types of mortgages to shop around and see if they can refinance into a fixed-rate loan.
“Compare what you’d expect the adjustable rate to go up to in the next year or two to what your payments would be on a fixed loan,” Carlisle said. “You have to spend time investigating the difference and see if you can afford a slightly higher payment in exchange for a guaranteed payment.”
For homeowners who already have fixed-rate mortgages, the rising rates will have no impact on their loans, noted Larry Pon of Pon & Associates.
“A client was freaking out when [he] saw Mortgage rates going up. He has a fixed 30-year Mortgage at 2.75%,” Pon said via email. Because this client had a fixed-rate mortgage, Pon told him he had nothing to fear from the Fed’s actions. “His heavy breathing stopped after I told him that,” Pon wrote.
What if you’re shopping for a home?
If you are about to take on debt or restructuring a loan you have already taken out, financial pros suggest wrapping up the deal quickly to lock in current rates before they go up.
“If you are considering refinancing, get the refinance done before the mortgage rates adjust. Check with your lender on how your rate is locked in,” Pon said.
He added, “If you are buying a car with an auto loan, check with the lender on when their rates might go up. Get the deal done before the new rates kick in.”
If you’re several months out from a big purchase, financial pros suggest waiting it out for six months or longer, if you can, until interest rates are potentially lower. If the US economy skids or goes into recession, the Fed will likely cut interest rates, making a range of financial products cheaper than they are now.
“Go about your life as you normally would, but for the two biggest purchases that most people make — buying a home and buying a car — I would sit tight for now,” said Rob Seltzer, a CPA and president of Seltzer Business Management.
Good news for fixed-income Savers
The upside of higher interest rates is higher returns for savers, as rates for savings accounts and CDs move up from their rock-bottom rates of the past year.
Some one-year CDs now offer a 1.9% return, according to Bankrate — significantly up from just four months ago, when the average yield was just 0.19%. Savings accounts now offer rates as high as 1.5%, and those should go up even more with the Fed’s hike.
To be sure, those rates are still far below inflation, which is running above 9%, but it’s an improvement for conservative savers and retirees, who have to keep a lot of their assets in fixed-income accounts, said Seltzer.
“They’re generally conservative investors, or should be, and they’ve been getting paltry returns,” he said. “For savers, [rising rates are] a good thing, because now you’re actually getting paid something on your savings and CDs and fixed-income instruments.”