What it means for your money when interest rates rise
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After years at rock bottom, interest rates are moving slowly and steadily upward. In late March, the Federal Reserve raised its benchmark lending rate to a range between 1.50 percent and 1.75 percent, the highest point since the 2008 financial crisis.
The median forecast reported is for another three nudges upward this year. Earlier this month Fed Chairman Jerome Powell reiterated the central bank’s commitment to a “patient” approach to raising rates.
Keeping interest rates low is a way of keeping money circulating in the economy, which promotes growth. This was a key strategy in recovery from the financial crisis.
But the central bank also tries to prevent inflation, which can sometimes happen when growth is too fast. These days, with unemployment trending downward, there’s a consensus that it’s time to let interest rates go back up. However, by historical standards, rates are still very low.
How low? Well, between 1978 and 1991 they never went lower than 5 percent.
Ten years of low interest rates is a long time — long enough that many will now have to update their working assumptions about how to handle their money. Here are some potential implications of rising interest rates.
- Borrowing will become more expensive. You may feel this in credit cards and auto loans, as well as in the rates available for student-loan refinancing. Federal student-loan interest rates are set by the Education Department each year on July 1 and pegged to the 10-year Treasury rate.
- Mortgages will get more expensive, and this could affect housing prices. Mortgage-lending standards tightened after the crash, and we thankfully left behind the era of zero-percent-down NINJA loans — short for no income, no job, no assets. However, mortgage rates that started with the numeral 3 allowed more people to enter the housing market. This meant more competition for housing and better prices for sellers. Today those average interest rates begin with the numeral 4 for a 30-year mortgage. If you’re selling, this could mean fewer buyers and a longer wait to get a price you like; if you’re buying, that dream home will cost you a bit more.
- Savings rates, now at rock bottom, should improve. For years it’s been nearly impossible to beat inflation by saving. As of this writing, the top rate on Bankrate.com for a plain-Jane savings account is 1.85 percent. The top rate on a five-year CD is 2.8 percent. Savings rates are getting better but are still not amazing.
- The effects on bonds are complex. When interest rates are rising, the price of fixed-rate savings bonds will fall. As long as you can hold your bonds to maturity, you don’t have to worry too much, but if you have to sell early, you could lose money. When it comes to bond funds, the falling prices will likely hurt total returns but not yields (the interest payments on the bonds).
- The effects on the stock market are hard to predict. The most recent period of very low interest rates has been accompanied by a run-up in the market. That doesn’t necessarily mean that it will work the other way.
Adjusting interest rates is supposed to prevent the nation’s economic car from overheating, so to speak — from out-of-control growth. If we were to overcorrect, into recession, that would obviously by definition hurt the stock market.
However, there is no ironclad relationship over time between interest rates and stock market performance. The stock market will react in the short term to each interest rate hike, but over a 10-year investment period you may not see much difference in your portfolio.
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