The Impact of Rising Interest Rates

It seems like everywhere you turn these days, folks are talking about how interest rates are on the rise. You see it in mortgage rates, as they have fluctuated upwards over the past several months. You hear it on the news – how Mr. Greenspan and his group are calling for a “tightening” (don’t they really mean choking?) mode. So what does this all mean to you and me?

Calling the direction of interest rates is a wild guess at best most times, and even the experts tend to disagree. But, since Mr. Greenspan and company are indicating that they intend to continue increasing their target rates, and since the economy is still shaking off a hangover, plus we continue to see fuel prices on the climb, it’s pretty certain that the near future rates we’ll see will be higher than what we’re seeing right now.

But the news isn’t all bad. Increasing interest rates mean that businesses are willing to pay more to borrow money, because prospects for revenue are increasing. Inflation rising, to a degree, is a good thing – it forces our economy to grow. Following are some of the ways that the increase in rates may impact you – some good, and some not so good:

Credit Card Debt – all of those low-interest credit cards that have variable rates tied to the prime rate are going to increase their rates, you can bank on that one. Now is the time to do what you can to reduce or eliminate any unsecured debt – meaning credit cards and personal loans – because you’ll not likely see rates at these levels again anytime soon.

Mortgages – If you locked in a fixed rate over the past couple of years, good for you! You’re in the catbird’s seat. The rise in interest rates should have no affect on your mortgage at all.

If, however, you’re sitting on a variable rate mortgage, you’ve got a decision to make: Should you refinance to a fixed rate loan, or sit tight and ride out the increase in rates? I’ve never been a fan of variable rate loans in general, so you can guess what my recommendation is here – go for the fixed rate, and do it now before the rates rise!

The one instance where a variable-rate loan might make sense is a situation where you absolutely know you are only going to be in the home for a period of time no more than the first adjustment term. In these cases, you’re actually just taking a fixed-rate loan of a very short duration that has been amortized over a longer time period, which makes good sense.

There are some new kinds of mortgages on the market these days that could suit your situation, called “hybrid adjustable rate mortgages”. With a hybrid ARM, your rate is fixed for a longer period of time than a traditional ARM, even up to as much as ten years. These loans could be just the right thing for your conditions.

Home Equity Line of Credit (HELOC) – if you have one of these at a variable rate, and you’re not intending to get it paid off fairly soon (within the next 12 months or so), you may want to consider changing it to a fixed-rate loan, in order to lock in your rate.

Auto Loans – usually these are at a fixed rate, so current loans shouldn’t be impacted, but if you’re considering purchasing a new car and financing it, you might want to act now before rates increase.

Stock Market – the jury is still out on whether or not a rise in interest rates is good for the stock market. If the economy is in expanding mode, it should be good for the market. However, if the interest rate increases are too much too fast, it can have a dampening affect on any attempts at a rally.

Bond Market – quite often, an increase in rates can have a damaging affect on the bond market. Now is the time to consider reviewing your bond portfolio and perhaps shortening your overall duration, in order to take advantage of the looming potential increases in rates. The rule of thumb is that an increase in rates has a tendency to impact longer-duration bonds to a greater extent than shorter-duration bonds and portfolios.

CD’s – typically, you’ll begin to see rates increase in the CD market, so if you have CD’s maturing soon, or you’re looking to add some money to your CD portfolio, now would be a good time to implement a laddering strategy. A ladder is where you have, for example, your CD money split up between three CD’s of differing maturity, such as one year, three year, and five year. As each CD matures, you reinvest it for five years, thereby reducing your exposure to interest rate increases while still getting CD-rates (versus savings account rates).

Treasury Inflation-Protected Securities (TIPS) – these bonds are a great place to take advantage of both the increases in interest rates as well as inflation. They are comparable in yield to CD’s at the present, and are as secure as the federal government.

In addition to the above-listed items, there are some benefits for folks that are intending to generate charitable trusts as a part of their estate planning activities. In some cases lower rates are in your favor, while rising rates favor other strategies. It gets fairly complicated, so if you’d like to discuss these options at any length, give me a call and we’ll talk it over.
So now, hopefully you’ve picked up a reason or two to pay more attention when the nightly news reports that the Fed is planning to increase rates, and perhaps you’ve got a couple of more items on your “To Do” list now. I hope that this list has helped you to face the coming increases in rates, knowing that you’ve done what you can to both shield yourself and to take advantage of the situation where you can.