This past week the Federal Reserve (Fed) raised interest rates a quarter of a percentage point. While this move was anticipated, it still has some significance for most people.
The reason interest rates have importance for consumers is that most of us are either savers or borrowers, and frequently are both. When interest rates change, it is going to have an impact on the cost of loans, or the interest received from a savings or money market account.
For a number of years the interest rate set by the Fed was essentially zero. This meant savers were receiving virtually no interest income. and borrowers were able to take advantage of low interest rates. Note some borrowers were still paying relatively high interest rates, but that was a function of one’s credit history rather than the interest rate environment.
It is important for consumers to realize that the period since 2008 of very low interest rates was unusual. People should recognize that is not the norm for what interest rates will be in the future.
This is not to imply that interest rates are going to go to double digit levels, which were experienced for a period of time in the early 1980s. However, people who have been paying 2 or 3% for auto loans will likely be paying rates somewhat higher in the future.
Because interest rates have been so low for so long it has allowed consumers to afford more expensive items. The low interest rate environment, coupled with more stable gasoline prices, has led to a proliferation of purchases of expensive trucks and SUV’s. With low interest rates consumers have kept monthly payments affordable by lengthening the term of their car loans.
Low interest rates have also been a major catalyst to the strong housing market we have seen in recent years. Certainly better employment growth has also helped. With housing prices at a record level in our local area, higher rates will certainly have an impact on affordability for a number of people.
For those who are savers they are certainly welcoming the higher interest rates. However, interest rates on most savings and money market accounts are still less than 1%, so whatever interest income being earned is quite small.
It should also be noted that when the Fed raises interest rates, the impact for borrowers is felt right away. For savers the adjustment period tends to be slower, as many banks do not raise deposit rates right away. For savers who have significant balances, checking with various financial institutions for the best rate would be beneficial.
The Fed has now raised interest rates a quarter point three times. The time lapse from the first rate increase to the second was an entire year, which was unusual. This last rate increase occurred three months after the previous one, which is more typical.
After the Fed raised interest rates they did give some guidance about future rate increases for the year. The expectation is for two more rate increases for 2017. This is actually a rather modest pace.
The Fed currently has their benchmark rate set at .75% to 1.0%. Two more rate increases would raise this rate to 1.25% to 1.5%. Even at 1.5% that is still a relatively low interest rate, when inflation is closer to 2%.
While the Fed is providing its guidance for the balance of the year, circumstances can easily change. Two more rate increases is based on the current environment, but a lot can happen over the course of a year.
The relatively slow pace the Fed has been raising rates has been a positive for the financial markets. However, consumers should be aware that this period of extraordinarily low rates is coming to an end, and should expect higher rates in the future.
