How the predicted interest rate hike in 2015 would impact consumer credit.
At the end of June, the President of the Federal Reserve Bank of St. Louis, James Bullard made waves by predicting the Fed will raise interest rates sometime in early 2015. Economists are now weighing on what this means for inflation and if it’s the right decision for our country’s economy in the current environment.
What isn’t being talked about is what a potential increase would mean for consumers. Yes, an interest rate increase may be good for the overall economy because it would help stabilize prices to avoid problems with inflation. Still, consumers may want to prepare now, since higher interest is never good for consumers who want to borrow.
Understanding Benchmark Rates
The Federal Reserve controls the “benchmark” interest rate. This is basically the starting point for all interest rate assessments. So when you apply for a loan or a new line of credit, the lender will use the benchmark as a starting point. From there, they assess interest based on various concerns like the type of loan you’re taking out and your credit score.
So basically, any increase in the benchmark means that consumers would face an increase on their own interest rates by a comparable amount. When the benchmark rate is low, you qualify for lower interest. When the benchmark rate increases, you will face higher interest rates even if your credit score is exactly the same.
Since the start of the global recession, the Fed has kept the benchmark rate at near zero in order to encourage lending as much as possible. The hope was that a near zero benchmark would promote new loans even in the face of an unstable economy; and for the most part, it’s worked.
Now that the economy is in recovery, the Fed wants to raise the benchmark rate to avoid problems with inflation. That’s good for our economy, but for borrowers, it means you may want to get loans now before the benchmark rate rises.
Borrowing ahead of the hike
From a consumer standpoint, the thing that really matters is what the hike would do to your own interest rates.
- For existing loans with a fixed interest rate, a rate increase should not have any effect. This is the big benefit of taking out fixed rate loans, because you don’t have to worry about what’s happening with the benchmark.
- Adjustable rate loans (such as ARMs for housing) would experience rate increases comparable to the increase on the benchmark. This means either your payments will increase and/or more of each payment would get taken up by interest charges.
- Any new loan or line of credit would be taken out at a higher interest rate following the benchmark increase.
With this in mind, it’s in your best interest to borrow now while rates are still low. If you have adjustable rate loans, call your lender to see if you can lock in your rate so you don’t have to worry about market fluctuations.
“An increase of 0.5 percent doesn’t sound like a big deal,” Gary Herman, President of Consolidated Credit acknowledges, “but when you’re talking about the interest paid over the life of a $150,000 mortgage, that small change adds up to a big difference in how much you end up paying.”
So how much is it, really? Let’s say you have strong enough credit that you can qualify for a $150,000, 30-year, fixed-rate mortgage at 4.5% APR now. Over the life of that loan, you’d pay $123,610.07 in interest charges by the time you make your final payment.
A 0.5 percent benchmark increase would mean you would qualify for that same loan at 5.0% APR even if you have the same credit score that you have now. At that interest rate, you’d pay $139,883.68 in added interest charges over the life of loan. That’s a difference of $16,273.61.
“It doesn’t take much of a change in your rate to cause a big difference in what you wind up paying,” Herman concludes. “So consumers need to maximize their credit scores now so they can lock in the lowest interest rates possible on mortgages, auto loans and even new credit cards.”