Why should you care?
By Nathan Gilbert
You may have seen some quotes and/or blurbs about “The Fed raising interest rates.” That’s not exactly an attention-grabbing or “interesting” (pun intended!) headline for most people, but it does have a direct effect on all of our financial lives. Even though interest rates have risen recently, we remain in an historically low rate environment. To state things very generally, low interest rates are good for borrowers and bad for conservative savers.
On March 15, the Federal Open Market Committee did in fact raise the federal funds rate (the rate banks in good standing pay to borrow from the Federal Reserve Bank) to a range between ¾ and 1 percent. For the most part this is a good sign as it means that the committee (chaired by Janet Yellen) believes that the economy is healthy. By the time this article is published, the Fed will have met again on May 3rd. It is thought that interest rates will remain that same for now.
From the Open Market Committee March 15 statement.
“Information received since the Federal Open Market Committee met in February indicates that the labor market has continued to strengthen and that economic activity has continued to expand at a moderate pace. Job gains remained solid and the unemployment rate was little changed in recent months. Household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat. Inflation has increased in recent quarters, moving close to the Committee’s 2 percent longer-run objective; excluding energy and food prices, inflation was little changed and continued to run somewhat below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.”
So what are the implications to you, the consumers?
If you are a 35-year-old looking to purchase your first home, you can expect to borrow at a rate somewhere around 4 percent for a 30-year fixed-rate loan. That’s not quite a record low, but it is very close. That same 35-year-old’s parents might have paid somewhere in the neighborhood of 16 percent for the same mortgage. Just to further make the point, the monthly payment for a $200,000 mortgage for the parents would have been about $2,690 per month, while today’s 35-year-old would only pay about $955 per month. That’s a very stark difference.
Conversely, the parents would have been ahead of the game when it came to conservative savings via Certificates of Deposit (CDs). They may have enjoyed rates around 10 or 11 percent for a 5-year CD, while today’s 35-year-old would be lucky to find a five-year CD that pays 2 percent.
Taking things a bit further, this may speak to some of the reason that the U.S. stock market continues to rise in the face of quite a bit of uncertainty. Savers who are relying on income for retirement or other reasons probably can’t afford to just stick to CDs. For most, 2 percent will not provide enough money on which to live. They are somewhat forced to explore other options such as stocks that pay good dividends.
The Federal Reserve has announced plans to raise interest rates two or three more times this year. Even if those increases occur as planned, borrowers will still be in a good position, and savers will still find it hard to earn high levels of interest at their banks.