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Is This Your Last Chance to Refinance?
If you follow any sort of financial news, it’s hard to escape buzz about interest rates. After intense scrutiny from every corner of the media, the Federal Reserve opted to leave rates at record lows during its last meeting in September. And recent lackluster economic data has made a rate hike before the end of the year seem less likely. But that hasn’t stopped the growing anxiety over when the Fed will finally change course.
Why all the speculation? Simply put, it’s because the Fed’s action (or inaction) on interest rates can have a ripple effect across the entire economy, from the stock market to job wages to home buying.
Below, we’ll focus on what a potential interest-rate rise can mean to you, and whether now might be your last chance to act on some big decisions, such as pulling the trigger on that home purchase, refinancing your mortgage, or stashing your money in that long-term CD.
What’s the Federal Funds Rate?
First, a quick refresher on what we’re talking about when it comes to interest rates and the Federal Reserve. The federal funds rate, set by the Federal Reserve, is the rate banks and credit unions use when they lend money to each other.
Generally, the Fed keeps this rate low (as it is now) to encourage banks to lend, benefiting businesses and stimulating the economy. When the Fed raises rates, it’s typically to combat inflation — that is, the incremental rise in prices for goods and services that cuts the purchasing power of your mighty dollar.
The federal funds rate is not a single number but a range: currently 0% to 0.25%. That range has been unchanged since December 2008, when officials dropped it to that rock-bottom level while the country was mired in a recession.
But now, the economy has been growing at a good clip for a while, and Federal Reserve Chairwoman Janet Yellen has recently said the Fed won’t hold off on an interest rate hike much longer.
Why Does This Matter to Me?
The Fed’s actions on interest rates can trickle down to you in many ways. When the Fed raises rates, you could pay a higher interest rate for mortgages, car loans, and credit cards. That’s because banks are paying more to borrow from each other at higher rates, so they’re passing some of that cost onto you.
Is the news all bad, though? Happily, no. While rising interest rates aren’t a good thing for you as a spender, they’re a very good thing if you’re a saver. As rates tick up, you will eventually get a little bit better of a return on your investment if you’re leaving your money in savings accounts, money market accounts, or CDs.
If Rates Are Going to Rise, What Should I Do?
If you need to borrow money, experts say you should consider doing it soon. For more than half the global economy, including the U.S., this is — literally — the best time to borrow money in all of history, a Bank of England economist recently found.
More specifically, you may want to consider the following:
Get the loan you need
Even a small bump in interest rates can cost you a significant sum on loans, especially for higher-dollar, long-term debt such as a mortgage, home-equity loan, or private variable-rate student loans.
At the beginning of October 2015, the benchmark rate for a fixed-rate 30-year loan was 4.01%, according to Bankrate. Borrow $200,000 at that rate, and you’re looking at paying about $956 a month and roughly $344,154 over the life of the loan. Borrow the same amount at 4.5%, and you’ll be paying $1,013 a month and $364,813 over the life of the loan.
Even if the extra $60 a month doesn’t throw a monkey wrench into your financing plan — and if you’re stretching to qualify for a mortgage, even a slightly higher monthly payment can derail your home purchase — look at the long term: You’ll be paying $20,000 more for your mortgage because of a mere 0.5% bump in your rate.
Despite that, experts say you shouldn’t panic. Conventional fixed-rate mortgages are tied to the 10-year Treasury note, which typically moves only gradually in response to interest-rate changes. Adjustable-rate mortgages, however, are more vulnerable to rate jumps in the short term.
For car loans, you’re unlikely to feel much heat from a small rate bump by the Fed. That’s due to both the shorter term of these loans and the fact that automakers, facing stiff competition, kick in a lot of their own cash to keep rates low and encourage buyers. However, if rates keep rising, car loans will eventually catch up, too.
If you’re already locked into your mortgage, especially if it’s an adjustable-rate loan, consider refinancing soon before rates go up. Just be sure to consider closing costs in your decision, which can be significant.
For instance, maybe you’ve determined that refinancing your mortgage at current rates can save you $200 a month. That’s great — but if you pay $6,000 in closing costs to refinance, you won’t actually break even for two and half years, at which point you’ll start to see actual savings. So if you think you might sell your home in the near future, refinancing might not be a great idea after all.
Consolidate your debt
Credit-card interest rates are unlikely to jump quickly, but they could start to tick up slowly after the Fed takes action. That’s because the prime rate benchmark on which your credit-card APR is based tends to track the federal funds rate. In a rising-rate climate, credit-card companies are likely to get more stingy about deals like 0% introductory rates.
Because of that, now might be an ideal time to consolidate your higher-interest debts with a single low-interest debt consolidation loan or a balance transfer credit card with a low introductory rate, provided you can pay it off before that rate adjusts to normal. Before you consolidate, though, remember this important caveat about debt consolidation: It can backfire if you don’t turn over a new leaf with your spending habits. In other words, don’t go on a shopping spree when lower credit card payments give you some budgetary breathing room, or you’ll find yourself right back where you started.
Don’t lock in your savings
You might be tempted by a five-year CD rate that outpaces the meager yield you’ll see from a typical savings account, but locking in that rate now might not be the best move. When the Fed raises rates, yields are also likely to tick up for savers, though it may take a year or two to see a significant bump in rates.
If you’re interested in long-term CDs, consider holding off for now, or trying out a CD ladder by investing in CDs with different term lengths that will let you invest at least a part of your money when rates rise in the future.
What If I’m Not Ready?
Not ready to pull the trigger on a big financial decision? Don’t panic, and don’t rush. Despite all of this breathless Fed-watching, no one expects rates to rise dramatically in a short period of time.
Instead, a longer, more meaningful rise could come in small increments. The first hike is expected to be a relatively small 0.25%, for instance, but if the Fed decides to keep going toward a “more normal” 3%, the impact will be much more dramatic.