Analysis: What the Fed rate hike could mean to mortgage borrowers

23 Dec 2015 | Author: | No comments yet »

Editorial: Fed gets off the dime.

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After seven long years of holding short-term interest rates at zero in fact or effect, the Federal Reserve has — as long predicted — increased its rate target all the way to a range of one-quarter to one-half of 1 percent. Within hours, Wells Fargo became the first in a steady parade of financial institutions to boost their own prime lending rates, with those increases taking effect Thursday. For a car buyer looking for a loan, an increase from 3 percent to a rate of 3.25 percent means an increase in the monthly payment on a $25,000, four-year loan of $2.76. Full offer terms and conditions apply – see www.theaustralian.com.au for full details. * Value calculated as at 24/11/15.Offer includes a free Samsung Galaxy Tab A 8” Tablet Model SM-T350NZAAXSA (WiFi Only).Please be aware introductory offers must be purchased before 18 December 2015 for delivery before Christmas Day.

The best customers at banks like JPMorgan Chase, KeyCorp, SunTrust, PNC, Citibank, Wells Fargo and many others now will pay a base rate of 3.5% for their consumer loans, instead of the 3.25% that has been in effect for the past seven years. It’s far from clear that the ultra-low rates engineered by the Fed through easy money have had any beneficial effect on the economy at all in recent years besides boosting the stock market a bit. We will supply your contact details to JB Hi-Fi, who will deliver this tablet only to your registered subscription address and will email you with dispatch details. But after such a long period during which lending rates haven’t budged an inch, any change is bound to come as a shock – especially when it’s simply the harbinger of more profound changes still to come. All the Fed’s dithering over what if anything to do about interest rates has only added to the uncertainty that every consumer, investor and business has had to deal with.

The rate hike announced by Federal Reserve chair Janet Yellen and her colleagues last week won’t be an isolated event, as they made clear in their statement after wrapping up their meeting and announcing their decision. The low rates have been a heavy drag on the incomes of seniors and institutions like pension funds, which want to avoid stock market risk by holding fixed-income securities. Business investment in the economy for the last seven years has grown at half the rate of the economy as a whole, and the rate of economic growth has been nothing to write home about.

That means that we need to brace ourselves for at least four more interest hikes next year – and four more opportunities for lenders to make all forms of consumer debt more costly. Dealing with those economic anemias is beyond the Fed’s ability; it is something Congress and the president have to tackle through tax and regulatory simplification. Speculation about the first post-financial crisis rate hike has been swirling around the financial markets throughout the year, and debt markets have priced in much of the movement.

When Yellen made the much-telegraphed announcement (having previously done everything except hire the Goodyear blimp to warn us all what was coming) the US stock market even staged a brief, daylong relief rally. So, while there’s no reason to panic about what modestly higher interest rates might do to your financial situation, or to financial markets, there’s a good argument for using the coming weeks to prepare yourself for what’s coming. Offers are available to new customers with an Australian residential address who have not held a digital subscription with The Australian in the 6 months preceding subscribing for this offer. Usually, banks will raise interest rates in order to attract cash in the form of deposits, but right now, they’re pretty flush with capital and don’t need to attract much more: they’re already wondering how to lend out what they already have in a prudent manner.

That means there is little incentive for them, at this early stage in the game, to move rapidly to pay more interest on savings accounts as the Fed raises rates. You can start shopping around for better options on both savings accounts (currently averaging a mere 0.1%, a fifth of the level it was back in 2006, according to Bankrate) and certificates of deposit, or CDs; yields on a one-year CD now average only 0.3%, down from 4% in 2006. The larger a deposit you are able to make (and in the case of a CD, the longer the time period you are able to tie up the money for), the higher the rate you are likely to find. While you’ll want to keep scrutinizing the landscape for opportunities that present themselves, in the next few months, your priority needs to be on the risk side of the ledger.

That’s because, as the prompt action of the banks with respect to their prime rates demonstrated, financial institutions will move more rapidly to make the costs of auto loans, credit card borrowing, home equity lines of credit, mortgages and other loans more costly. If you’ve got an adjustable-rate mortgage that has an annual readjustment feature, you really should be talking about refinancing your mortgage into a fixed-rate structure before the impact of a series of rate hikes begins to take its toll. Anyone with any kind of floating rate debt should evaluate their financial situation, calculating not only what they can afford to pay at today’s interest rates but if interest rates rise a full percentage point between now and the end of 2016.

One of the contributing factors in the mortgage crisis that began in 2007 was the fact that too few people understood how much they would have to fork out every month on their adjustable rate mortgages when interest rates rose. Still, before making the switch from variable to fixed interest rates, check to see it makes sense, given your balance and the time remaining on the loan, since fixed interest rates tend to be higher.

If you’re a disciplined borrower and know you won’t load up your cards with fresh spending (and you’re in a financial position to do so), you might be able to take out a home equity line of credit or other bank loan at a lower interest rate than your credit cards are offering and use the proceeds to pay off the balance on your cards.

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