The Federal Reserve’s latest rate hike is the ninth increase in the last 12 months — for a total of 475 basis points. The current Fed Funds target rate is 4.75% to 5%; a year ago it was less than 1%.
As a result, Americans have received a very public lesson in interest rate risk, and its impact on the banking system. But now it’s getting personal. The next impact will be on your own family budget.
Silicon Valley Bank and others bought safe 10-year government securities at low rates two years ago, planning to hold them to maturity. Then interest rates rose. And when depositors wanted their money back immediately, banks had to sell those bonds at a loss.
It’s a lesson that conservative investors learned in 2022, when their 60/40 portfolios lost money in both stocks and bonds. Bond holdings are “supposed” to cushion stock market declines.
But when interest rates rise, bond prices fall. No one will give you $1,000 for your old 2% 10-year government bond when they could currently buy the same quality bond paying 4%. The market price of your old bond drops sharply — if you’re forced to sell, instead of waiting for maturity.
For consumers, the most immediate impact of Fed rate hikes has been the cost of mortgages. A year ago, 30-year fixed-rate mortgages carried an interest rate of just over 3%. Amid Fed increases, mortgage rates soared to over 7% — slowing home sales and impacting prices. In fact, in February, the median home price dropped for the first time in 10 years!
As I write, the national average rate on a 30-year loan is 6.85%, according to Bankrate.com.
Higher mortgage rates slowed home sales dramatically in recent months. People with low-rate mortgages are staying put.
But one group of current homeowners is facing a shock in monthly payments. They took on adjustable-rate mortgage loans last year, lured by lower starter rates. Adjustable rates soared at mid-year 2022 and now, even with annual or quarterly caps on increases, monthly payments on these loans are starting to rise significantly.
Perhaps the most dangerous example of interest rate impact comes on credit card balances and monthly bills.
The average interest rate on credit cards is now 20.38%, according to CreditCards.com. And with Experian reporting the national average card balance at $5,221, the interest cost is soaring.
According to credit card expert Bill Hardekopf, since almost every card issuer charges a variable rate, the impact of even a quarter-point Fed hike is felt in 60 days. For those making only minimum monthly payments, the long-run cost is significant.
Says Hardekopf: “Assuming that average balance of $5,221, at the current interest rate of 20.35%, someone paying the typical 3% minimum balance payment would take 11 years and 6 months to pay off the entire balance. They would make interest payments of $5,532 for a total payment (interest plus balance) of $10,753.
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“A year ago, when the average rate was 15.6%, someone paying just the minimum balance would take 9 years and 3 months to pay off the balance. They would make interest payments of $3,285 for a total payment (interest plus balance) of $8,506.
“So these interest rate hikes would cost someone carrying an average balance an extra $2,247 in interest payments, and take an extra 2 years and 3 months to pay off the balance.”
The lesson is that these quarter-point increases being passed along to variable-rate borrowers will do big damage to personal balance sheets. It’s not just the financial system feeling the impact of the Fed’s fight against inflation.
If you are in credit card debt, your best choice is to find a temporary second job and put all those extra paychecks toward paying it down. Or get trusted help from an agency of the National Foundation for Credit Counseling by calling 800-388-2227.
Personal loans, though with lower rates, don’t really solve the problem. And debt consolidation set-asides ruin your credit and can lead to wage garnishment.
Now is the time to deal with your debt. If you have credit card balances, you’re no longer treading water by making minimum monthly payments. You’re drowning. And that’s The Savage Truth.
(Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” Terry responds to questions on her blog at TerrySavage.com.)
