December 14, 2016 | Marshall Weintraub, CFP, and Michael Merrill, CFP, CLU, ChFC
Career Development

If you have tuned into the financial news recently, you may have heard about the Federal Reserve possibly raising interest rates in the near future. The Federal Reserve is the U.S.' central bank and is mandated with using monetary policy to control price stability (inflation) and achieve full employment (which does not mean unemployment is 0 percent), two measures of a healthy, stable economy. One of the main tools the Fed has at its disposal is the ability to influence the interest rate environment by directly setting the discount rate and influencing the federal funds rate (rates at which the Fed charges member banks for overnight loans and at which banks charge each other, respectively). These rates are important because they serve as a baseline for other interest rates, from mortgages to bond yields. This article will review how we got to our current low interest rates and how a rise in rates may affect your finances.

Why are interest rates so low?

Interest rates have been trending down since their high in the early 1980s; however, the current ultra-low interest rates are a result of the Fed's monetary policy following the 2008 Financial Crisis. The actions of mortgage lenders, investment banks and insurers (among others) created a large amount of systemic risk that resulted in one of the worst recessions since the Great Depression of the 1930s. This necessitated swift intervention from the Fed to prop up the economy. One of their first actions was to lower interest rates to effectively zero to make borrowing inexpensive. Low mortgage rates encouraged families to buy homes, aiding the battered housing sector. Business also took advantage by borrowing to refinance their debt and fund expansion plans.

The possibility of an interest rate increase has been met with mixed feelings by analysts on Wall Street. On one hand, it indicates the Fed is confident in the economy's strength to bear higher borrowing costs – a positive sign. On the other, it could create a headwind for businesses that have grown accustomed to operating in a low-rate environment, slowing or reversing progress achieved during the recovery.

How might a rise in interest rates affect my finances?

For individuals and families, an interest rate hike may be favorable or unfavorable depending on your current situation and future plans. For example, prospective home buyers have been securing mortgages at very low rates over the last several years. A rate increase from the Fed would pass through to lenders and likely cause them to issue mortgages at higher rates. We would expect a similar rate increase in student loan refinancing offers. Borrowing new debt or refinancing debt would not be as favorable as it has been in the recent past. Existing homeowners with adjustable-rate mortgages may see their interest rate rise if they are beyond the initial fixed-rate period, which would increase their monthly payments. Those who expect to continue living in their home for several years may benefit from refinancing adjustable-rate debt to a fixed rate to lock in today's lower rates.

Conversely, the interest rate your cash earns in a savings account would likely increase, benefitting savers. New bonds would likely be issued at higher coupon rates, providing a higher yield to bondholders. This would benefit retirees, many of whom rely on bond interest payments as a source of their income.

In Conclusion...

Despite the stock market reaching record highs over the summer, the recovery has been considered delicate by other standards. Economic development has not picked up to the level desired and inflation has yet to reach the Fed's target of around 2 percent, prompting the current chair of the Federal Reserve, Janet Yellen, to take a measured approach when considering possible rate increases. Even with positive economic signs, we would expect the current Fed leadership to raise rates at a gradual pace. We would encourage individuals and families to keep interest rates in mind, but not allow them to dictate or accelerate a lifestyle decision, such as when to buy a home.

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This article was authored by Marshall Weintraub, CFP®, and Michael Merrill, CFP®, CLU®, ChFC®.

Marshall Weintraub & Michael Merrill are financial advisors with the independent financial services firm, Finity Group, LLC. To ask them questions or arrange a consultation, email them at Marshall.Weintraub@thefinitygroup.com. Office Address: 4380 SW Macadam Ave, Suite 245, Portland, OR 97239. Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Finity Group, LLC and Cambridge are not affiliated.