It’s been big news everywhere in the financial world for a
while now. The Federal Reserve, the U.S. central bank, finally made its move
this month and decided to raise short-term interest rates.
These are the rates at which banks borrow money from each
other. The Fed also projected that there might be as many as three additional
rate hikes next year. Additionally, Donald Trump’s presidential election
victory and speculation about what his economic policy might look like has
pushed interest rates up in recent weeks.
We thought we would take a look at why the Fed occasionally
messes with home loan interest rates. After that, we’ll get into the effects
for consumers.
Inflation Inhibition
An original goal specified by Congress when setting up the
Federal Reserve was that it should maintain stable prices, keeping the cost of
goods and services from getting too high or too low.
The main tool that the Fed has for doing this is controlled
short-term interest rates. For the better part of the last decade, we’ve been
in a cycle where the Federal Reserve has wanted to keep money free-flowing and
borrowing costs low. It’s been cheaper for banks to borrow money from each
other, with banks passing that onto regular consumers looking to pay for a
house or car.
While low-cost borrowing can be great, there can be too much
for good thing. That’s when inflation happens. Eventually, if there’s too much
money floating around, it doesn’t hold the same value. If I were elected President
Graham tomorrow (shudder), and I decided everyone gets 50 $100 bills, we might
find ourselves paying $25 or more for a loaf of bread.
Admittedly, that’s an oversimplified example, but the Fed
has to balance keeping borrowing affordable for Americans with the need to keep
inflation in check. In order to keep inflation from getting out of hand, the
Fed will occasionally choose to raise short-term borrowing costs for banks. In
turn, this means borrowing gets more expensive for the consumers of the bank.
If the Fed feels borrowing has become too expensive, they lower rates again.
Consumer Effects
Now that we’ve learned what the Fed does and why my Monopoly
money monetary policy would never work, let’s take a look at what it all means
in the real world. How do rising
home loan interest rates
affect you?
Mortgages
Let’s start with something we know quite a bit about – the
mortgage market.
Mortgage rates have certainly gone up recently. Rates
started going up after the election and they haven’t stopped yet. The election
played into this. The market had also expected the Federal Reserve to raise
interest rates in December, so that was accounted for in mortgage rates before
the decision was ever made. However, there was one thing the market did not
expect.
Prior to December, the Federal Reserve had projected two
interest rate increases over the course of 2017. At its final meeting of the
year, the Fed decided to change its projections to include three interest rate
increases in that timeframe. This had the effect of pushing more money out of
bonds, making mortgage rates higher.
Bonds give a fixed rate of return. That means they’re not a
great investment in an environment where there’s a lot of inflation. For
example, you buy a $100 bond for $50 with a term of 10 years. Sounds like a
good deal, right? Invest $50 and get back $100. Sure, it is. However, there’s
the possibility that if you invest that $50 in a certificate of deposit, you
could’ve turned it into $200.
If the Fed is raising home loan interest rates, it means the
central bank thinks inflation is going to soon reach a level that needs
controlling. Again, inflation is not good for bonds.
When people have a feeling they could make more money
elsewhere, they leave one market for the other. That’s what’s happening with
stocks and bonds right now. No one knows for sure what’s going to happen with
the economy when President-elect Trump takes office, but the stock market is
way up because people think his policies will be good for business. This
encourages people to take a little risk on the success of companies rather than
stay in the safety of bonds.
Whether you’re looking to buy or refinance, rates are still
relatively low at this point, especially in comparison to other times in
history. However, if you’re on the fence, it’s an excellent time to lock that
low rate.
Other Interest Rate
Effects
Although we talked to this point about the impact of rising
interest rates have mortgages, it would also have a high impact on things like
variable rate credit cards, where the home loan interest rates periodically
change with the market.
Get More Out of Your
Savings
The Federal Reserve is raising interest rates in order to
make borrowing more expensive and combat inflation, but this has a sneaky
positive effect as well.
If banks have to pay more to borrow money that makes the
money you’ve been keeping with them that much more valuable to them. Because of
this, you should be able to start getting more money out of your savings, CDs,
etc.
Impact of a Stronger
Dollar
As inflation is brought under control, this has an
interesting impact on a global level. For the same reason your savings account
grows, your money becomes more valuable compared to other global currencies if
there’s less of it in the marketplace. This has two effects:
·
That futuristic Japanese toilet and all manner
of other imports become cheaper for us to buy because our money is worth more.
·
Our exports become more expensive for other
consumers around the world as the dollar strengthens. This is what the Fed has
to keep an eye on because they don’t want the higher prices to cause a sales
slump for American companies.
Hopefully this has given you a better idea of what this new,
higher interest rate environment might mean for you. It’s also important to
realize they’re still not all that high right now. If you’re looking to buy or
refinance soon, check out current mortgage rates.
{Source: https://www.quickenloans.com/blog/rising-interest-rates-mean-wallet}
