NEW YORK (MainStreet) — With the Federal Reserve planning to raise interest rates later this year, consumers should take stock of their current debt and consider refinancing or paying down mortgages or credit cards.
Increases in interest rates will be “measured” and likely to occur in the 0.25% to 0.5% range, said Greg McBride, CFA, Bankrate.com’s chief financial analyst. If the Fed believes there is further tightening of the economy, interest rates may not change.
“The Fed uses short term interest rates as a way to jump start the economy when it’s running slow and to hold prices in check and to keep the economy from overheating when it’s doing better,” he said. “The Fed will raise them gradually and is very deliberate in their decisions.”
Pay Off Credit Card Debt While Rates Remain Low
Interest rates are expected to increase only modestly later this year, which bodes well for consumers who are faced with mounting credit card debt or auto loans. The Fed ended its quantitative easing program in 2014, which was intended to boost the economy and keep borrowing costs low for consumers after the Great Recession in 2008.
While the impact on monthly credit card payments is “pretty minimal,” it is more advantageous for consumers to pay down debt when rates are low, rather than when they are rising, McBride said.
Despite the lower rates, consumers should not fall into the habit of carrying credit card balances from month to month, said Bruce McClary, spokesman for the National Foundation for Credit Counseling, a Washington, D.C.-based non-profit organization.
“A habit of carrying balances can be hard to break when interest rates start to increase on variable rate accounts, leaving the cardholder with a costlier debt to repay,” he said.
Many credit card companies are currently offeringb0% balance transfers, but the number of offers will dwindle as the Fed raises rates.
“Grab those rates now while you still can,” McBride said. “As the Fed eventually moves away from a 0%, credit card issuers will do the same. Over time those offers will dissipate.”
Low Mortgage Rates Will Rise
The smaller increases in interest rates means consumers have greater purchasing power and can borrow money at a lower cost. Mortgage rates will remain “well below” 5% throughout 2015 and increases in mortgage rates won’t start until the second quarter and will “work their way higher slowly,” which presents a refinancing opportunity for homeowners who missed previous opportunities because they lacked enough equity, he said.
While mortgage rates remain very low, homeowners who are on the fence about refinancing should take advantage of them. Buying a house should still remain a decision for consumers who are financially prepared and are looking before they leap, McBride said.
“The economic troubles elsewhere around the globe are helping to keep them at these very low levels,” he said. “Any increases we see as the Fed timetable comes into focus will be very measured.”
Increases in home equity loans and lines of credit will also be very manageable and will rise slowly in the second half of the year. An increase of 0.5% increase on a $30,000 loan equals to an additional $12 a month, McBride said.
Any increases in auto loans will not occur until later in 2015 and should not impact affordability since a 0.5% increase on a $25,000 loan will costs drivers an extra $6 a month, McBride said.
Savings and Retirement Portfolios Will See Boost
The Fed will raise rates gradually due to the sluggish labor market and disappointing wage growth, said Gus Faucher, a senior economist at PNC Financial Services Group, a Pittsburgh, Penn. financial institution. One positive indicator is that the University of Michigan’s consumer sentiment index rose to its second highest since 2007 in April and is “more evidence that U.S. growth should pick up after a slow first quarter,” a recent PNC report said.
While rates will increase slightly for savings and money market accounts, consumers should not expect big hikes. Prices of stocks will remain volatile, while bond prices will decline; however, the dips will be “small movements,” he said.
When interest rates rise, the prices of bonds will always fall because of their inverse relationship, said McBride.
“Lots of individual investors are due for a rude awakening when long-term interest rates start to move up,” he said. “Look at how your assets are allocated. Don’t have too much money piled into bonds.”
Higher interest rates are a “reflection” of an improved economy and should be viewed as a positive sign for increased corporate earnings and stock prices in the future, McBride said.
--Written by Ellen Chang for MainStreet