Every time the Federal Reserve raises interest rates, people start to panic.
What does a rate hike mean? Will it make it harder to buy a home? Are credit card companies going to increase their interest rates? Will lenders become more stringent?
Many consumers are still unaware of how these rate hikes will affect their finances down the line, so here is a basic primer on how the fed rate hike will change your finances—and if you need to change your financial strategy.
What does a rate hike mean?
When the Federal Reserve increases interest rates, it means they think the economy is strong enough to handle the increase.
The Fed decreases rates to stimulate the economy and they increase rates to control inflation. They don’t want consumers to be priced out of the market so they use interest rates to control spending and lending.
How a rate hike affects variable rate loans
Credit card rates go up
Interest rates on variable rate loans increase every time the feds raise interest rates. Your rates will increase if you have a loan or credit product with a variable rate loan, including adjustable-rate mortgages and credit cards.
Credit card rates especially depend on the market and if the fed increases rates, credit card companies will increase the rate on their cards.
Consumers who pay off their balance every month won’t notice a difference, but millions of Americans carry debt on their credit cards. Each time the credit card issuer increases the APR, their debt will take longer to repay.
The average American has credit card debt of $6,375. If their interest rate changes from 18 percent to 19 percent and they continue to make the minimum payment, their total interest paid will increase from $8,985.76 to $9,499.90. If the Fed increases rates again, then the credit card issuer could raise rates again.
Consider a balance transfer card if you have debt
Again, this only matters if you carry a balance. If you have credit card debt and are worried about increasing rates, try finding a 0 percent balance transfer offer on a different card.
If you pay off the balance before the 0 percent offer ends, you could save thousands on interest.
Our favorite balance transfer card right now is Discover it® Balance Transfer.
How a rate hike affects mortgages
Mortgage rates rise
Any time the Fed increases interest rates, mortgage lenders will increase rates for potential homeowners. The Fed rate affects how much banks pay in interest, so when banks have to pay more, they pass along the difference to their customers.
This means if you take out a mortgage now, you’ll likely pay a higher interest rate than someone who took out the same mortgage last year. Since the Fed will likely increase rates again in the future, now is the best chance to lock in a low rate.
However, mortgage rates are still low
However, rates are still relatively low for mortgages and no one should rush into a major decision like a house just because they’re worried they’ll have a higher interest rate.
“For example, the Fed has increased rates several times since December 2015 but the average 30-year mortgage rate has only increased by less than half a percent (0.45 percent),” said chartered financial analyst Joseph Hogue.
If you have a mortgage with a rate higher than today’s average rate, now might be a good time to refinance if you were considering it. If you have an adjustable-rate or variable rate mortgage, you might be seeing some increases in your monthly payment. Overall, the type of mortgage you will determine whether or not your payment will change.
Bond values go down
The value of bonds goes down when interest rates go up. Because bonds are set ahead of time and cannot be changed, their value decreases as interest rates go up. A bond with 1.5 percent interest will be worth less when interest rates change.
“People who invest in these safe investments recognize it as interest rate risk,” said Jim Wang of Wallet Hacks.
This doesn’t mean you should stop investing in bonds. Bonds provide important diversification to stocks and act as a buffer. When the market drops, bonds are there to help ease the fall in a person’s portfolio. People who solely invest in stocks will not have the right buffer in case another recession happens. Conversely, being only invested in bonds is rarely appropriate for anyone, even a current retiree.
Diversify your portfolio before rates rise
Doug Nordman of The Military Guide said people who are properly diversified don’t have to care too much when the Fed raises rates. If you have a portfolio that fits your investment strategy, age and retirement plan, you don’t have to panic and sell off assets when the Fed changes interest rates.
“An asset allocation resembles a thermostat—you set it for your comfort level and stop worrying how hot or cold it might be outside,” Nordman said. “If interest rates rise at a measured pace (as the Federal Reserve tries to do) then a diversified portfolio will respond well. If there’s a shock, then a diversified portfolio will minimize the damage and offer an opportunity to buy more shares at cheaper prices.”
If you’re concerned about how rising interest rates will affect your investments, contact a licensed financial planner who specializes in investing. They’ll be able to offer you advice on your portfolio and show you how to rebalance your assets if you’re not properly diversified.
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