At the March 14-15 policy meeting, Federal Reserve Chair Janet Yellen announced a hike in interest rates by 0.25 percentage points. The rate now stands at 0.75% after having hovered around zero for some seven years as the Fed struggled to encourage economic activity following the financial crisis.
The move signals confidence in the state of the economy and represents a calculated bet in its resilience to tightening. “The simple message,” Yellen told reporters, “is the economy is doing well.” Her optimism was supported by the first full employment report from Trump’s Labor Department, which recounted a fall in unemployment to 4.7% and inflation closing in on 2%.
If the economy continues along this course, Fed officials anticipate a further two hikes this year. In an interview with CNBC on Tuesday, Vice Chairman Stanley Fischer underlined his expectation that this will be appropriate.
Consumers will be quick to point out that the slow but steady improvement in economic indicators means little to them if it is accompanied by a worsening of the lending climate. Generally speaking, a hike means two things for consumers: higher earnings on savings and higher interest charges on loans, potentially making buying a home, attending a university or buying a car relatively more expensive.
Perhaps unsurprisingly, no two borrowers will be affected the same way. Those with variable rate loans will be particularly affected. When it comes to home buying, that means that homeowners with variable rate mortgages or home equity lines of credit will face higher payments.
A 0.25 percentage point rise may on its own represent a negligible increase for sizable variable rate mortgage payments and in households with looser budgets. Similarly, the rate change likely will not manifest as a massive increase in monthly payments on auto loans. Prospective car owners should simply ensure that they carefully peruse financing offers to ensure they are getting the best possible rates.
Nonetheless, when it comes to mortgages, refinancing or switching to a fixed rate may be worth considering for homeowners in the context of gradual increases. “There is no sense in bearing the risk of an adjustable rate when you can lock in a fixed rate at essentially the same level,” said Greg McBride, Bankrate.com’s chief financial analyst.
Most credit cards these days also have a variable rate. Credit card owners carrying a balance will find themselves particularly hard hit by the hike. A WalletHub analysis estimated that the 0.25 percentage point increase will cost consumers around $1.6 billion in extra finance charges in 2017, driving up the amount paid by the average household from $1,333 to $1,350 per year, according to NerdWallet.
It will be a good idea for indebted households to aggressively increase their efforts to pay off their high-interest debts as soon as possible, and those with good credit should consider a balance transfer to a lower or zero interest rate card.
In a rising-rate environment, building a good credit score and credit history will be increasingly fruitful. For some consumers, this could mean paying a visit to a credit repair company so they may need to check out a few as they prepare for the next phase of rate hikes. Paying bills on time, applying only for loans you need and using a credit card with no annual fee are some of the ways that consumers can improve their likelihood of getting good rates on new loans.
The surge in interest rates should also be interpreted as an opportunity. Banks will eventually respond to the hike by paying customers higher interest on their deposits. As savers start earning interest, opening up a savings account or saving generously will most likely pay off more than usual.
In addition, Robert Johnson, president and CEO of the American College of Financial Services, thinks that investors should consider investing in stocks that perform well in rising-rate environments. For example, in the long run, financial entities like banks, insurance companies and brokers tend to be good bets as their margins expand as rates climb. By this token stocks to look at might include Bank of America (BAC, Financial), Allstate Corp. (ALL, Financial) and The Travelers Companies (TRV, Financial).
At the same time, minor increases in the interest rate should not form a justification for diverging from long-term consumption or investment plans and strategies. Going into the second fiscal quarter of the year, it behooves consumers to respond to the hike with the same levelheadedness and gradualism with which Yellen introduced it.
For some consumers, paying down high-interest debt will become more difficult and more time-sensitive, fixed rate mortgages will have the upper hand over variable rates, and saving will be more attractive.
Disclosure: No position in stocks mentioned in this article.
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