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Extra
Say goodbye to record-low rates
Credit cards, adjustable-rate mortgages and even the once-impervious 30-year fixed-rate mortgage are rising quickly. You need a game plan.
By Bankrate.com
Seven interest rate hikes are now in the books, with the fed funds rate now up to 2.75 percent from the 40-year lows of 1%. So what are all these quarter-point interest rate moves adding up to? And more importantly, what significance might the rate moves made since last summer have in the coming months and years?
The latest interest rate hike means more indigestion for anyone dining on the buffet of low interest rates during the past several years.
To a family with $10,000 in credit card debt and $30,000 in home equity debt, interest rate increases have had a relatively modest effect on monthly payments, with a total increase of just $40. But it is important to note that the cost of carrying that debt has increased by $40 per month, to say nothing of the added burden of repaying that debt. However, rising interest rates mean more than just higher rates on home equity lines of credit and credit cards.
For a look at how long it will take for the increase to show in various rates from loans to credit cards, click here.
The biggest impact is felt by households with adjustable-rate mortgages. A one-year ARM for $200,000 that adjusts by 2 percentage points sees the monthly payment increase by approximately $230.
How about those pervasively marketed Option ARMs that permit borrowers to choose which monthly payment they wish to make? A similar increase in rates would drive the interest-only payment on a $200,000 loan up by $333. The danger, of course, is that with such a loan the borrower could instead make the more-affordable minimum payments that actually push the balance higher.
While fixed-rate mortgages were immune from the effects of the first six Fed interest rate hikes, inflation concerns are now fueling increases there, too. In the past six weeks, the average 30-year fixed-rate mortgage has increased by more than half of 1 percentage point, from 5.59% on Feb. 9 to 6.15% as of March 23.
Buckle down on your debts
The run-up in bond yields and mortgage rates began with Federal Reserve Chairman Alan Greenspan's "conundrum" comment in his prepared congressional testimony on Feb. 16. To the bond market, which is the basis for rates on mortgages, it is a comment that parallels in significance the "irrational exuberance" remark aimed at an overinflated stock market in 1996. The message was clear: Long-term interest rates must rise. Mortgage rates are indeed rising and forecasts say there is more to come in the balance of 2005.
Might the higher rates on both fixed and adjustable-rate mortgages be the precursor to the popping of real estate bubbles that exist in many markets? The answer will not become evident overnight, but will instead unfold as rates escalate.
Rising interest rates are bad news for borrowers, but good news for savers. Unfortunately, American households have done too much borrowing and too little saving.
Snap out of the borrowing mode
All types of consumer debt have continued to grow in the past four years, despite low interest rates that make repaying debt easier. The average non-mortgage debt per household has increased by nearly $3,500 since 2000. Will households burdened by debt be further handicapped by having to repay the debt in a higher-rate environment, or will they perhaps eventually file for bankruptcy protection under a much stiffer Chapter 13 that would mandate some repayment?
Although interest rates are still low relative to historical norms, we are no longer in an environment of record low interest rates. People can no longer afford to operate with the mindset that we're at 40-year lows in interest rates. Buying a home with the expectation of continued annual appreciation in excess of 5% or 6% is begging for disappointment.
Buying that home with interest-only or adjustable-rate loans without having a game plan to pay down the balance and counteract rising interest rates is asking for trouble. And continuing to use borrowed money to finance a lifestyle rather than striving to repay the debt already owed is flirting with disaster.
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