How Fed Rate Hikes Will Affect Borrowers Next Year

— -- The Federal Reserve raised interest rates on Dec. 14 for only the second time in a decade. You probably saw some headlines about mortgage rates or credit card costs and then went back to furious holiday preparation or clicked on another story about Donald Trump. After all, what’s a quarter point? Well, you have time to correct that mistake, but not a lot of it.

The announcement that should have caught your eye wasn’t about the Fed funds target rate ticking up from 0.5 percent to 0.75 percent (yawn). No, something much more dramatic happened that day. Federal Reserve officials said they expected three more rate hikes in 2017. And two or three in 2018 and three in 2019.

So let’s review: two rate hikes in a decade, three rate hikes in 2017. That’s news.

So now we’re looking at a jump to 1.25 percent next year. While you probably shouldn’t fret about a 0.25 percent increase in car loan costs or even credit card rates, you should definitely be thinking about what a continuously rising interest rate environment might mean for you and your money.

There is no guarantee that rates will rise another 0.75 percent next year. Fed Chair Janet Yellen herself said the Fed would need to take a wait-and-see approach as President-elect Donald Trump implements his economic plan. But clearly Yellen was yelling to anyone who would listen that the price of money will be going up soon. You should listen to her.

While it’s true that higher rates are generally bad for many consumers, higher rates are more of a mixed bag than you might think.

The Rebirth of Savings

Anyone in the 1970s who was good with money will talk about how much they miss double-digit certificate of deposit rates. They’re not coming back any time soon, but the good, frugal savers of our world have been punished in the last decade as central banks around the world kept rates low to encourage economic activity. That policy, as all economic policies do, picked winners and losers, and it made losers out of savers. The average traditional passbook savings rate in America has been stuck around 0 percent for a decade. Even specialized high-yield online savings accounts have been stuck at less than 1 percent.

If you are the type to pile up cash for a rainy day (and you should be), there is finally good news. Higher rates will eventually lead to folks earning a little interest income on their rainy day funds. That should give you emergency fund laggards out there fresh incentive to put away the recommended three to six months’ of living expenses.

But this good news comes with a big pile of caveats. Savings rates are not directly tied to the rates set by the Federal Reserve, like student loans or mortgages. Instead, they are tied to simple market pressures. Banks will give you as little interest as they can and will raise rates only when competition dictates.

So don’t expect your bank to magnanimously raise rates in the next month or two. In fact, banks pretty much ignored last year’s small 0.25 percent rate increase when it came to savings and CD rates. Institutions are better at making money off price movements than consumers. Suffice it to say that banks will simply pocket the profit on the gap between the interest they pay for depositors’ money and the higher rates they charge to lend people money as long as they can.

But that doesn’t mean higher returns are nowhere to be found. And keep in mind that as you work on your emergency savings next year, you might find 2 percent rates on CDs, so that should really inspire you to stash some cash.

It Might Get Easier to Borrow

This one is counterintuitive, and not without controversy, but the idea is simple: As mortgage rates go up, fewer people will want new mortgages and even fewer people will want to refinance their existing mortgages. That makes sense: Refinancing is only worthwhile when rates are low.

The Urban Institute says that about half of all mortgage loans were refinanced in 2016; higher rates will drop that percentage.

“As mortgage bankers try to compensate for the huge decline in mortgage originations, they will be more likely to lend to creditworthy borrowers who have less-than-perfect credit, borrowers who currently find it difficult to obtain a mortgage,” the Urban Institute said in a blog post. “This happened in 2000, the last time there was a major rate increase. Interest rates in 2000 were, on average, close to 100 basis points (or 1 percent) higher than in 1999 or 2001. Volumes plummeted, but credit access expanded.”

Not everyone agrees with that assessment. California mortgage expert Logan Mohtashami thinks that lending standards are already fairly relaxed, so unless there’s a return to the crazy no-doc loans of the past bubble (and there probably won’t be, as financial reform passed during the recession essentially outlawed them), there isn’t much room to expand the borrowing pool.

You can be sure that banks missing all that refinancing activity will try to do something to replace it. More aggressive advertising? Free toasters? Ten-minute mortgages? We’ll wait and see.

There is another potential silver lining for some folks. Higher rates mean higher monthly mortgage payments. In some areas, the higher costs could decrease the buying pool, which might slow the increase in housing prices in some overheated local markets, or at least take the pressure off the bidding wars happening right now in places like Seattle and Pittsburgh.

Speaking of Mortgages ...

Folks who are afraid that rates will rise by perhaps 1 percent or so might race to buy homes in early 2017, and that could increase price pressure for buyers (and help sellers, at least short term). Generally, higher mortgage rates are all but assured in 2017.

I’ll say it again because it bears repeating: Don’t fret about a 0.25 variation in your rate. It’s far more important to buy the right house at the right price than to quibble over small fluctuations in rate. On the other hand, if the difference starts to approach a full percentage point — well, you can see where I’m going. It might make sense for you to house shop this winter than next fall.

“Worst case on rates is 1.25 percent Fed funds rate for 2017. That is where we were in the previous recession before rate hikes happened,” Mohtashami told me. “Inflation would really need to take off for this to (change) … 2017 looks good.”

A Word on Home Equity Loans

This thinking applies to home equity loans and home equity lines of credit (HELOCs). The price of both will go up in relative lockstep with Fed rate increases. So if you are thinking about borrowing money to redo the kitchen soon, you would be wise to add the cost of delaying that choice into your calculations. Of course, other factors are more important, like competition for contractors in your area. But know that your borrowing costs will be higher the longer you wait.

As for HELOCs, they just won’t look as good in 2017. When rates are very low, it can make sense to lock in low borrowing costs for a project you might be planning, or an emergency you might face. HELOCs generally come with variable rates, meaning the main benefit of a HELOC — quick access to a lot of money with low borrowing costs — starts to fade. And your monthly costs will rise. Now is a good time to reexamine why you have a HELOC and think about converting it into an old-fashioned home equity loan, which would lock in the rate. Or just dump it.

Bad News for Private Student Loans

Borrowers with good federal loans don’t have anything to fear from Fed rate hikes — their rates are locked in. On the other hand, about half of private student loans have variable rates, according to FinAid.org. Those loan rates are ultimately set on the Fed funds rate, meaning former students with private variable rate student loans need to study up now.

Now is the time to renew your efforts to kill off the variable, private portion of your school borrowing, as your costs have just gone up, and they could go up three more times soon.

Some Thoughts on Auto Loan Rates

Yes, car loans will be a bit more expensive in the 2017 rising interest rate environment, but I’m less concerned about this one. Car makers will keep finding ways to get borrowers with good credit into new cars (including 0 percent long-term loan incentives). In fact, Detroit and its foreign competition seem hell bent on getting borrowers with bad credit into new cars, too.

Still, small interest increases don’t make that much difference with shorter-term car loans. A driver who borrows $25,000 for a 72-month car loan at around 3 percent sees only a slight monthly increase for each 0.25 percent rate hike.

Credit Card Rates Will Be Worst of All

You constantly hear that paying down credit card balances should be your first priority, no matter your station in life. (I disagree; piling up an emergency cash fund should take at least equal priority, but you get the point.)

Now, there should be no confusion: Pay down those balances ASAP. Credit card rates are rising right now in reaction to the Fed increase, and they are going in only one direction next year.

Immediately after the Fed increase on Dec. 14, JPMorgan Chase, Wells Fargo and Bank of America all announced increases to their prime rate, which is used to calculate your credit card interest rate. Credit card debt is going to get more expensive quickly next year, and you’d be a fool not to hear Yellen’s warning on this and respond.

Bob Sullivan is a contributor to Credit.com and an author of The New York Times best-selling books "Gotcha Capitalism" and "Stop Getting Ripped Off." His stories have appeared in The New York Times, The Wall Street Journal and hundreds of other publications. See more at www.bobsullivan.net.

Any opinions expressed in this column are solely those of the author.