Interest rates are almost undoubtedly rising this month, for the first time in three years.
The Federal Reserve is expected to raise its benchmark interest rate by 0.25% next week to curb inflation, which is at its highest level in 40 years. Further increases are likely later this year.
According to financial advisers, American households will feel this political impact in several ways, both positive and negative.
“The Fed’s rate hike is hitting just about every corner of the economy,” said Andy Baxley, a certified financial planner at the Planning Center in Chicago.
Higher interest rates mean more expensive financing for borrowers.
This is true for mortgages, student loans, auto loans, credit cards, margin loans on investment accounts, and other types of debt.
“The higher rates go, the harder it becomes to be a borrower,” Baxley said.
Let’s say a consumer wants to buy a house for $500,000; they get a $400,000 mortgage at a 30-year fixed rate. They would pay about $80,000 more over the life of the loan and about $200 more each month with a mortgage rate of 4% versus 3%, for example, Baxley said.
According to Cathy Curtis, CFP, founder of Curtis Financial Planning in Oakland, Calif., income requirements and down payments increase with mortgage rates, which means first-time homebuyers may want to speed up their search so they don’t be out of the market.
Consumers buying a new car should also speed up that process to avoid more expensive auto loans, Curtis said. It may also be a good time for investors with margin loans in their brokerage accounts to focus on paying off that debt, she added.
Borrowers with variable interest rates should also weigh refinancing at a fixed rate now or try to pay off their debt sooner, advisers said.
However, potential buyers should still be in a good financial position to make a purchase.
“Rushing to save money by buying could lead to financial hardship, which could be much more costly in the long run,” according to Lauryn Williams, CFP, founder of Worth Winning in Dallas.
On the bright side, higher mortgage rates could cool a boiling housing market and bring house prices down to earth, she said.
Higher interest rates will likely put pressure on growth stocks, financial advisers say. These stocks are issued by companies that have the potential to grow at above-average rates relative to the broader market.
These companies (the classic ones being big tech companies) thrive when interest rates are low because they can invest in innovative projects at lower cost, Baxley said.
“It could be a tough road for growth stocks,” he said.
Investors may inadvertently be overweight growth stocks due to the large returns from this part of their portfolio. They should allocate more money to value stocks — the easiest way being to buy a value-oriented mutual fund or an exchange-traded fund, Curtis said.
Bonds will also likely lose money in the short term. This is because bond prices move opposite to interest rates.
The dynamic is more pronounced for long-duration bond funds (those whose bonds mature in 10 years versus 1 year, for example), the advisers said.
“If you have to pay for college or buy a house in a year, you shouldn’t be thinking, ‘I can’t lose money on bonds,'” said Ted Jenkin, CFP, co-founder of oXYGen Financial in Atlanta.
However, in the long term, higher interest rates ultimately mean higher returns for bond investors; new bonds are issued at higher yields that match prevailing interest rates.
3. Savings accounts
The national average interest rate for savings accounts is a measly 0.06%, according to a March 2 poll by Bankrate.
But consumers will likely see higher interest on their bank account if the Federal Reserve acts. Online banks offering high-yield accounts tend to pay higher rates than traditional banks, advisers say.
Rates on other savings accounts like certificates of deposit would also increase.
“It’s important to do rate buying if you’re trying to take advantage of these gains,” Baxley said.
The gains likely won’t be immediate, though. According to Jenkin, it usually takes several months to a year for banks to raise savings account rates.
The reason the US central bank raises interest rates is to cool the economy to keep inflation under control.
If the policy has the desired effect, consumers should see recent rapid increases in the prices of food, clothing and other goods and services begin to moderate.
This ripple effect stems from rising borrowing costs. More expensive financing means less investment by consumers and businesses, which cools demand in the economy and tames prices.
5. Jobs and wages
However, weaker demand could impact jobs and wages in some parts of the economy, Baxley said.
Strong demand for workers and a tight labor supply have led to record job creations and rapid wage growth in recent months.
“I think people have gotten used to this being the first worker-friendly hiring climate in a while,” he said. This dynamic could change with higher interest rates, he said.