Federal Reserve Raises Rates, Promises More Hikes
After much speculation, promises, and false starts — but little surprise — the Federal Reserve finally raised interest rates by 0.25% in their December 2016 meeting. The Fed also signaled a bit more confidence in the economy by projecting more interest rate hikes in 2017.
If that sounds familiar to you, it should. The Fed followed the same path in 2015. Expectations of multiple rate hikes dispersed throughout the year transformed into a single 0.25% rate hike at the end of the year.
Does that mean that we should expect 2017 to be economically similar to the last two years? Not necessarily, especially with the looming uncertainty introduced by President Donald Trump.
Strong Growth at Last?
America's stock markets have been experiencing a sharp rise since the election, reaching record levels and reinforcing the market belief that Trump's policies are more likely to produce strong growth to back up the Fed's 2017 plan.
Federal Reserve Chairwoman Janet Yellen cited higher inflation and the lower-than-expected unemployment rate (4.6% for November 2016) as primary factors in their decisions, but acknowledged that Trump's economic plan of tax cuts, reduced regulation, and economic stimulus was considered by some Fed officials in producing the forecast.
Assuming this year is different — and that we really see accelerated economic growth and continued rate hikes — what do those rate hikes mean for you?
Pre-emptive Mortgage Rate Increases
Fed interest rate increases are generally bad news for homebuyers, as banks pass on their increased borrowing costs. In this case, the effect may not be as noticeable. Mortgage rates have already been on a sharp rise since the election.
According to the St. Louis Fed, the average on a 30-year fixed rate mortgage climbed from a pre-election 3.54% to close last week at 4.16%, the highest value since October 2014. The effects of the Fed's rate hike have already been partially priced into the market, making the rate hike itself somewhat anti-climactic.
In short, the Fed's announcement should not cause such an upward shift in rates that it causes you to abandon your plans, but it would be wise to review affordability. As a guideline, every 0.25% in rate increases raises your monthly payment by $14 per $100,000 borrowed. How much can you afford to pay for your preferred home given a higher interest rate, and what are the odds that your situation will change for the better before rates rise again?
A Tough Time to Refi
If you are looking to refinance your existing home, it's hard to put a positive spin on the rate hike. Many homeowners who qualified for refinancing have already taken advantage of the low interest rates in recent years. Others who were underwater (owing more on the mortgage than the value of their home) now face higher refinancing rates if they do recover enough equity in their home to qualify.
According to Zillow, as of October, median home values had risen 6.2% in the past 12 months to close in on pre-recession values. If home appreciation continues, a new group of people would be able to qualify for refinancing as they gain a windfall in home equity. Those with pre-recession fixed rates (typically high 5% or low 6% range since 2003) should still see a large enough difference in interest rates to make up for the refinancing costs and still come out ahead.
Provided rate hikes stay low and are spread out — and even with 2017's uncertainties, history suggests that they are likely to do so in the short term — these homeowners have a potential window to gain relief. Unfortunately, that window narrows with every rate hike.
More Than Mortgage Ramifications
While the focus of Fed actions usually relates to mortgages, other borrowing costs will rise as well. Auto loan rates should increase, as will variable term credit card rates. Carrying a balance on your credit cards could become disproportionately expensive because of the higher relative rates (20% and above is not uncommon) and the magnified effects of compounding.
Student loans are also likely to rise, as they are tied to the rate of 10-year Treasury issues. The Fed's actions should keep those on the upswing as well.
Your best response to rate hikes: keep your overall debt load as low as possible, especially revolving credit card debt, to minimize your collective interest payments and increase your odds of being offered a favorable interest rate for any new loans or lines of credit.
A Little Good News
What about the effect on your retirement plans? There are so many unknowns with the upcoming change in power that trying to assess the effect of one small interest rate hike on retirement plans borders on futile. Certainly, the markets have priced in higher growth, but as long as your investments are balanced (as they should be), you should be able to handle any upcoming fluctuations. Remember that retirement goals are long term and resist the urge to engage in speculation.
It's best to stay the course with your retirement plans — but if you haven't reviewed your plan in some time, now is a great time to do so and see if you are still on track to meet your goals.
In the end, you should pay attention to interest rate hikes but keep them in historical context. Rates are still extremely low compared to historical averages, and they are not anticipated to rise a great deal over the short term. Your personal situation takes greater precedence.
Use online calculators to try different scenarios for mortgages, auto loans, and similar extensions of credit — they can help you determine the total amount you can afford to spend on a fixed-rate loan with certain assumptions. It's then up to you to decide whether or not to move forward, scale back your plans to a more affordable purchase, or wait and run the risk of paying even more in the future to finance your purchase.
Meanwhile, the best thing you can do is focus on your overall debt load and credit score. A sufficient increase in your credit score can negate any interest rate hike by the Fed. You can see your credit score and credit report for free within minutes with Credit Manager by MoneyTips.
If you decide to wait, use the time wisely. Make sure all payments are on time, focus on limiting spending and paying down your debt, and avoid opening any interim lines of credit. You'll have a greater chance of coming out ahead regardless of what the Federal Reserve, President Trump's administration, or the Congress decides to do.
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