On September 21, 2022, the Federal Reserve raised interest rates by three quarters of a percent. This represents the fifth time the federal reserve has raised rates in the last 6 months. These interest rate hikes are in response to the significant inflation consumers have experienced throughout many areas of their lives as a result of the Covid-19 pandemic, supply chain disruptions, and the war in Ukraine. The cost of gas, groceries, clothing, cars, and other electronics are estimated to be 15% higher than they were this time last year. The Fed’s rationale for raising interest rates is that higher rates will make it more expensive for consumers and businesses to borrow money. Subsequently, consumers and businesses may put off their projects requiring financing or abandon them altogether. In turn, these higher interest rates lead to decreased spending and lower the amount of money in circulation in the US economy, which tends to lower inflation and “cool off” the economy.
While the long-term goal of these interest rate increases is to slow inflation and reduce the everyday spending for most Americans, there are significant short-term challenges that consumers may face in the coming months. Below we outline some of the most common.
Presumably, mortgage rates are one of the primary drivers affecting housing affordability in recent months. Because mortgage interest rates are such an important determinant of how much house you can afford, the recent interest rate spike has created a predictable slowing in what was a hot real estate market just several months ago.
According to Freddie Mac, if you were buying a $500,000 house this week, with a 30-year fixed interest rate and a 20% down payment, your average interest rate would be 6.7%. This would lead to an estimated monthly payment of $2,976. Similarly, if you were to make this exact purchase in December 2020 when the average interest rate was 2.66%, your monthly payment would be $2,008. This represents a $968 increase in current monthly payments for the same loan, based solely on the significant increase in interest rates. In this scenario, a homebuyer would spend $11,616 more over the course of a year and $348,480 more over the 30-year course of the loan. This scenario illustrates the extreme impact of interest rate hikes on housing affordability.
The takeaway: Unless you have a substantial down payment for your next home, you may want to wait for interest rates to go down before borrowing large sums of money for a home purchase.
Other Personal Loans (Car/Small Business)
Just as banks must borrow money from the government to lend money for mortgages, the same holds true for car loans and small business loans. Like the cost of buying a home, many consumers are being priced out of new car purchases based on how much they must borrow to finance the purchase.
Further, concerns among small business owners looking to borrow additional capital to expand their business are growing. According to CNBC, “Businesses are healthy today, especially those in the rebounding services sector, and credit performance remains good throughout the small business community, according to lenders, but the Fed’s more aggressive turn against inflation will lead more business owners to think twice about taking out new debt for expansion.”
Savings/Money Market Accounts
There is some short-term good news, however, for those Americans who have held their cash in Savings and Money Market accounts over the past few years. Top yielding savings accounts and certificates of deposit are passing along the increase yield from rising interest rates as payouts to remain a competitive option for savers’ money.
In conclusion, we must all remember that these significant interest rate hikes, just like inflation and current stock market volatility, are not permanent. While we all may be feeling the effects in our everyday lives, our best path forward is patience as we wait for these economic factors to normalize. Patience – not panic – is always the best path forward when considering important financial decisions for you and your family.