How to Prepare for Rising Interest Rates: Watch Variable Loan Rates, Mortgage Costs and More
By April Fowell
The Federal Reserve has increased interest rates three times in 2023 so far, after raising them seven times in 2022.
The most recent hike, of 0.25 percent, took place in May of 2023. With this most recent hike, the fed funds rate is at its highest since August 2007-that is, the target range of 5 percent to 5.25 percent.
Its goal is to bring inflation down, as it is almost at its highest point since the 1980s. Due to growing concerns about the banking industry and potential economic slump, only one more rate rise was anticipated by analysts in a recent Reuters survey.
Aggressive rate-raising tactics may have long-term negative effects on a variety of facets of consumer life.
Find out more about things to look out for when interest rates rise to safeguard your finances:
(Photo : by FREDERIC J. BROWN/AFP via Getty Images)
A credit card is placed into a credit card machine for processing payments on September 11, 2023 in La Puente, California. Credit card debt from US consumers is rising by billions of dollars amid higher inflation and interest rates, topping $1 trillion for the first time in history, according to the Federal Reserve Bank of New York
Rise in Variable Loan Rates
When interest rates rise, borrowers with variable prime rate loans, also referred to as adjustable-rate loans, will experience an increase in their payments. The cost of a variable loan might rise faster than that of a fixed-rate credit.
It might make sense to pay off a variable loan as soon as feasible or convert it into a fixed loan when interest rates are expected to climb.
Fall in Bond Markets
With rising interest rates, bond markets often decline. In order to further limit market liquidity, Federal Reserve Chair Jerome Powell stated in May 2022 that the bank will shrink its $9 trillion stockpile of mortgage-backed securities and government bonds beginning in June.
Nonetheless, throughout the majority of the previous year, both short- and long-term government bond yields increased month over month and year over year, albeit some are now starting to decrease. Think about changing your investing tactics in light of this.
Rise in Certificates of Deposit Returns
When interest rates rise, certificates of deposit (CDs) can provide higher annual percentage returns, which attracts new investors. However, when interest rates climb sharply, holders of long-term CDs at lower rates might wish to think about withdrawing money early (after accounting for penalty charges).
Rise in Money Market Accounts
Money market funds, like savings accounts, may receive higher rates of return with an increase in interest rates. A money market account often provides a better rate of return than the majority of savings or checking accounts. These funds frequently make investments in financial instruments such as repurchase agreements, bankers' acceptances, and CDs.
Rise in Mortgage Costs
Since the 30-year fixed-rate mortgage is dependent on long-term interest rate trends, potential buyers will incur more costs as rates climb. Instead, a buyer can choose a 15-year fixed-rate mortgage, which will result in a lower interest rate but higher monthly payments due to the shorter loan duration.
On May 3, 2023, the average interest rate for a 30-year fixed-rate mortgage was 6.49% nationwide, while the interest rate on a 15-year fixed mortgage was 5.90%. Increasing interest rates won't have an impact on homeowners with fixed-rate mortgages.
The Federal Reserve's decision to raise interest rates for the third time in 2023 reflects its commitment to curbing inflation, currently approaching levels not seen since the 1980s.
The most recent 0.25 percent hike in May brings the fed funds rate to its highest since August 2007, with a target range of 5 percent to 5.25 percent.
Analysts, citing concerns about the banking sector and potential economic downturn, anticipated only one more rate increase in a recent Reuters survey.
The aggressive rate-raising strategy, while aimed at stabilizing the economy, may have repercussions on various aspects of consumer life.
As rates climb, borrowers with variable loans face increased payments, bond markets may decline, and mortgage costs are set to rise, impacting potential homebuyers. However, opportunities arise for investors in certificates of deposit and money market accounts, offering higher returns in response to the interest rate hike.
With these shifts, individuals must consider adjusting their financial strategies to navigate the evolving economic landscape. Stay informed and vigilant to safeguard your finances amidst these changing conditions.
Related article: Interest Rates May See Dramatic Rises, But Not Because of Inflation