After 80 months, the Federal Reserve is getting serious about ending their zero interest rate policy. There has been speculation that this would happen since the beginning of the year, but at the Fed’s next meeting on September 16 and 17 the “zero rates” will most likely die and a new cycle of higher interest rates will begin. Understandably many investors are nervous about how a rate hike may impact the American consumer.
Investors are already on high alert after our most recent market correction and China’s economy seeming to slow. Adding to this anxiety, financial experts are clamoring to say which way the Fed will go. Bill Gross, a bond guru, and Rick Rieder, Blackrock’s CIO of Fixed Income, are both calling for a September rate hike. On the other side, Christine Lagarde, the Managing Director of the International Monetary Fund, does not believe that the global economy is ready for a rate hike.
Taking a step back, we as investors have to understand that the Fed hasn’t raised interest rates since 2006, and in fact, interest rates have been at historic lows since 2008. The Fed did this so that borrowing money for most people and companies would be inexpensive and, therefore, increase spending and stimulate the economy. That’s why things like mortgage rates have been so low in the past few years.
It might sound tempting to simply keep interest rates low, but money can’t be almost “free” forever. Eventually, the rates have to go back to a more “normal level.” To give the “normal level” some perspective, remember that the Fed Funds Rate, which has been kept at zero for so long, was in the 4 to 5% range in 2006 and 2007.
The Fed will eventually have to raise the Interest Rate, but people are wondering if now is the best time. Sure, with the threat of a raised rate, perhaps more people will borrow money now before it gets expensive again. Raising rates will also tell the world that we are confident in the U.S. economy and that it’s strong enough to handle it. People are nervous, though, that making money more expensive again will damper consumer spending.
Now that you understand the “why” part of the Fed rate hike, let’s circle back to the important question of how it will impact you. Personally, I don’t believe that a small percentage rate increase will negatively impact consumers in the short-term. However, over an extended period of time a series of increased rate hikes will certainly impact everyone. Knowing that the Fed will raise rates sometime soon, now is a great time to make sure your finances are ready for the rate hike. Here are three ways I suggest you start:
- Reduce variable debt – This includes debt like student loans, auto loans and home equity lines of credit. Even if you only have debt in one of these areas, you’ll want to try and pay down that debt. While you might not feel the effects of one small rate hike, you’ll definitely feel the pain as additional rate hikes are added down the line.
- Consider transferring your credit card balance – It’s likely that credit card interest rates will go up if the Fed raises interest rates. If you’re carrying a lot of credit card debt then your monthly payments could increase substantially. I suggest you spend time now looking for zero-percent balance transfers or introductory rates.
- If you have an adjustable rate mortgage, consider refinancing – This is a good time to lock into a fixed-rate mortgage. Like I said above, the Fed raising the interest rate by a small percentage should only minimally impact your monthly payments now, but with additional interest rate hikes over time those payments will continue to grow.
At Wela, we’ve been preaching about staying calm and not panicking over the market volatility or China. We’re going to say the same thing about the possible Fed rate hike… don’t panic. Just like you can’t control the markets, you can’t tell the Fed to hold off on a rate hike. Instead, focus on what you can control. Reduce your debt to avoid unnecessary financial pain in the future.