NEW YORK (MainStreet) — Interest rates are expected to increase only modestly later this year, which bodes well for consumers who plan to finance their purchase of cars and homes.
The Federal Reserve is expected to increase interest rates by June or later this year, which will only have a slight effect on mortgage and auto loan rates, CDs and credit card rates, said Greg McBride, CFA, Bankrate.com’s chief financial analyst.
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. Interest rates are currently at 0%, and increasing them too quickly could result in inflation, experts said.
Not all Federal Reserve bank presidents are in agreement that interest rates should rise this year. Chicago Federal Reserve Bank President Charles Evans told CNBC's “Squawk Box” on January 9 that an increase should be delayed despite the fact that the unemployment rate declined to 5.6% from 5.8%.
“We shouldn’t be raising rates before 2016 if things transpire as I’m expecting,” he said on CNBC. “I think employment growth has been very good for quite a long time now, and that’s been an important criteria for us to judge success. I’m in favor of being patient on raising interest rates.”
The Fed is only likely to raise interest rates “a couple of times in small increments,” from its current 0% to 0.25% and then move to 0.5%, McBride predicts. The Fed and other experts are forecasting larger and more frequent increases.
“The Fed is laying the groundwork for the eventuality of higher interest rates, but they will tread carefully once they do because of the weak global economy,” he said.
A stronger U.S. dollar and falling inflation could “derail” the Fed and do “some of the work for them,” McBride said. Weakness in countries such as Europe, Japan, China and emerging markets could lead to greater uncertainty and volatility in the global economy, he said.
“This could lead the Fed to push back or delay rate increases,” McBride said.
Small 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.” This presents a refinancing opportunity for homeowners who missed previous opportunities, because they lacked enough equity, he said.
The likelihood of mortgage rates rising above 5% remains “drastically low” and should hover between 4.5% to 5% by the end of 2015 because the rates are market driven, not sector driven, said Edison Byzyka, vice president of investments for Hefty Wealth Partners in Auburn, Ind.
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.
This year should be another great year for new and used car sales, since a 0.5% increase on a $25,000 loan will costs drivers an extra $6 a month, McBride said.
Many credit card companies are currently offering 0% balance transfers, but the number of offers will dwindle as the Fed raises rates.
“Now is the time to jump on it,” McBride said. “It is a great opportunity to transfer the high balance and use that 18-month window to attack that debt and pay it off.”
While savers will continue to lament the low rates for CDs and savings accounts, the good news is that yields will move “slightly in the right direction as the year progresses,” he said.
Most CDs with less than a three-year maturity are paying less than 1%, said Patrick Morris, CEO of HAGIN Investment Management in NY. A 0.25% increase in rates would push 2.5-year rates over 1% and 4-year rates over 2.0%.
“This is not a growth area, so banks compete by offering the highest rate possible to attract depositors,” he said.
Both CD rates and bond yields will remain historically low, said Bob Johnson, president and CEO of The American College of Financial Services in Bryn Mawr, Pa.
“As soon as the Fed adopts a more restrictive monetary policy, interest rates will rise, leading to higher CD rates and higher yields on bonds,” he said.
Large amounts of money flowed into bonds, as investors sought a safe haven during the downturn, but people need to realize that when interest rates rise, the prices of bonds will always fall because of their inverse relationship.
“It’s going to be a tough year for bonds if rates go up,” McBride said. “Look at how your assets are allocated. Don’t have too much money piled into bonds.”
Bond yields will be affected by the pace of interest rate hikes since the “quicker the pace, the more detrimental it is to the average investment grade bond,” said Byzyka.
--Written by Ellen Chang for MainStreet