When Will Interest Rates Go Up?
Are You Ready for Higher Interest Rates?
Interest rates will continue rising into 2019. But rates for savings accounts, mortgages, certificates of deposit, and credit cards rise at different speeds. Each product relies on a different benchmark. As a result, increases for each depend on how their interest rates are determined.
All short-term interest rates follow the fed funds rate. That's what banks charge each other for overnight loans of fed funds. The Federal Open Market Committee raised the fed funds rate by a quarter point at its December 19, 2018, meeting. The Committee is encouraged by steady economic growth, positive jobs reports, and a healthy inflation rate.
Long-term rates follow the 10-year Treasury yield. As of December 18, 2018, it was 2.82 percent. Normally, as the economy improves, demand for Treasurys falls. The yields rise as sellers try to make the bonds more attractive. Higher Treasury yields drive up interest rates on long-term loans, mortgages, and bonds. There are five steps you can take to protect yourself from higher interest rates.
Savings Accounts and CDs
Interest rates for savings accounts and certificates of deposit track the London Interbank Offer Rate. That's the interest rate banks charge each other for short-term loans. Banks pay you a little less than Libor so they can make a profit. Savings accounts follow the one-month Libor rate, while CDs follow longer-term rates.
Libor is usually a few tenths of a point above the fed funds rate. As a result, the return you receive on your savings accounts and CDs will also rise in 2019 and 2020.
Credit Card Rates
Banks base credit card rates on the prime rate. It's what they charge their best customers for short-term loans. It's three percentage points higher than the fed funds rate. Banks can charge anywhere from 8 percent to 17 percent more for credit card rates, depending on your credit score and the type of card.
Expect these rates to increase over the next two years. It's a good idea to pay off any outstanding balances now before rates get higher.
Home Equity Lines of Credit and Adjustable Rate Loans
The fed funds rate guides adjustable rate loans. These include home equity lines of credit and any variable rate loans. As the fed funds rate rises, so will the cost of these loans. Pay them down as much as you can to avoid any surprises over the next two years. Where it makes sense, talk to your bank about switching to a fixed-rate loan.
Auto and Short-Term Loans
Fixed interest rates on three to five-year loans don't follow the prime rate, Libor, or the fed funds rate. Instead, they are about 2.5 percent higher than one, three, and five-year Treasury bill yields. Yields are the total return investors receive for holding the bills.
The U.S. Treasury sells Treasury bills, notes, and bonds at an auction for a fixed interest rate that loosely tracks the fed funds rate. Investors can then sell them on the secondary market. Many other factors influence their yields. These include the demand for the dollar from forex traders. When demand for the dollar rises, so does demand for Treasurys. Investors will pay more to buy them. Since the interest rate doesn't change, the overall yield falls.
Demand for Treasurys also increases when there are global economic crises. That's because the U.S. government guarantees repayment. All these factors mean interest rates on long-term debt aren't as easy to predict as those based on the fed funds rate.
On the other hand, as investors receive more yield for short-term bills, they'll want a higher return for long-term notes. But if they lose confidence in the economy, they will buy long-term bonds regardless of the yield on short-term bills. That will flatten the yield curve. If they fear a recession, they will prefer long-term bonds to keep their investments safe. If that happens, the yield curve inverts. The Treasury yield curve inverted before the recessions of 2001, 1991, and 1981. The yield curve also predicted the 2008 financial crisis in 2006.
When rates are rising, it's best to keep your fixed-rate loans. Rising interest rates won't affect them. But if you need a new loan, apply for it now before rates rise further.
Mortgage Rates and Student Loans
Banks set fixed rates on conventional mortgages a little higher than the yields on 10-yr, 15-yr, and 30-yr Treasury bonds. Interest rates on long-term loans rise along with those yields. The same holds true for student loans. Mortgage interest rates closely follow Treasury note yields.
Now is not the time to refinance a fixed-rate mortgage for an adjustable rate. For new home buyers, don't get an adjustable rate mortgage just to afford a bigger house. It's better to get a fixed-rate loan, even if it means you can only afford the smaller house.
State, municipal, and corporate bonds compete with U.S. Treasurys for investors' dollars. Since they are riskier than U.S. government bonds, they must pay higher interest rates than Treasurys. That's true for all other types of bonds.