Some advice for borrowers and investors: Take a deep breath
WASHINGTON — If you’re about to buy a home, shop for a car or borrow for college, the pros have some advice:
The Federal Reserve’s decision Wednesday to slightly raise its key interest rate, advisers say, should have little effect on mortgages or auto and student loans. The Fed doesn’t directly affect those rates, at least not in the short run.
Nor should the economy’s health be much affected by the Fed’s move.
That said, rates on some other loans — notably credit cards, home equity loans and adjustable-rate mortgages — will likely rise soon, though only modestly. Those rates are based on benchmarks like banks’ prime rate, which moves in tandem with the Fed’s key rate.
Mortgage rates have been surging, for reasons that have little to do with the Fed. Rather, Donald Trump’s election as president — with his pledge to slash taxes, loosen regulations and increase infrastructure spending — has raised the prospect of faster economic growth and inflation.
In response, the rate on the 10-year U.S. Treasury note has jumped about half a percentage point. Long-term mortgage rates tend to track the 10-year Treasury. The average rate on a 30-year fixed home loan is up nearly in lockstep with the 10-year Treasury — to about 4.1 percent from 3.5 percent.
“The Fed isn’t what’s influencing mortgage rates right now,” said Greg McBride, chief financial analyst at Bankrate.com.
Next year, if the economy picks up as many predict, the Fed might accelerate its rate hikes. That would be cause for consumers to consider paring short-term debt, like adjustable-rate loans and credit cards. Shorter-term consumer rates are most affected by the Fed.
But longer-term rates are influenced by factors beyond the Fed, from inflation expectations to economic outlooks. And those trends can be shaped by events abroad as well as in the United States.
Since Trump’s election, investors have sent stock prices up and demanded higher bond yields. Faster economic growth tends to benefit stocks. And higher inflation erodes the value of bonds; their yields then rise until buyers return.
Yet it’s unclear if investors’ expectations will pan out. The markets appear to expect Trump to get Congress to enact steep tax cuts, a huge spending package to upgrade roads, bridges and airports and a softening of regulations in banking, energy and other sectors.
Tim Hopper, chief economist at TIAA Global Asset Management, says that if Congress appears sure to pass those proposals, the 10-year Treasury’s yield could rise a further half-point to 3 percent. That would likely happen, he says, even if the Fed delays further rate increases until mid-2017 or later.
But at least some of Trump’s proposals could face resistance in Congress. They might not pass — or at least not for months or even years.
“Markets seem to be pricing in this Goldilocks scenario where everything in Washington comes together for a tax cut and stimulus,” says Scott Anderson, chief economist at Bank of the West. “That’s a little Pollyanna-ish.”
If Trump’s program stalls and investors foresee less inflation and growth, the 10-year yield — and mortgage rates — could end up declining. Other factors could complicate the picture: The dollar has surged on expectations of higher growth and interest rates. A higher dollar makes U.S. goods costlier for foreigners and could slow the economy.
A stronger dollar could also cause pain in emerging markets, where companies have borrowed in dollars and could struggle to repay those loans. Tremors in the global economy could spill into the United States and slow growth and inflation. That would likely lead to lower rates.
“Just because the Fed’s raising short-term rates doesn’t mean long-term rates are going up,” McBride says.
That’s a point for Americans to keep in mind as they consider taking out a home or auto loan. Mortgage rates and other borrowing costs won’t likely rise in a straight line, which is why most people need not rush to lock in a rate.
“If you’re a first-time homebuyer, yes, rates are higher than they were in September, but they’re still reasonably attractive,” says David Geibel of Girard Partners, a wealth management firm in King of Prussia, Pennsylvania. “You can still get a very juicy mortgage.”
Still, with some other categories of loans, like credit card or variable-rate debt, many advisers are recommending that clients lighten their loads. Variable-rate loans would begin to charge more interest.
“If their credit score is high enough that they can go out and get an installment loan right now and pay those credit cards off, they should do that,” said Joe Heider of Cirrus Wealth Management in Cleveland. “If they have the ability to use a home equity line, they should be doing that as well to pay down those credit cards.”
Rising rates can erode the value of investors’ longer-term bonds. So they may not want to own many bonds that mature more than 10 years out, whether they’re individual bonds or mutual funds that hold long-term bonds.
“Longer-term bonds are going to most likely be the biggest losers if the Fed embarks on a cycle of raising interest rates,” said Ken Moraif of Money Matters, a wealth management firm in Dallas. “Shortening up the duration of the bonds in your portfolio is a very good idea.”
Moraif has his clients now in bonds that mature in five to seven years.
Don’t go too short, though. Though you’ll lower your risk, you’ll also unduly limit your potential returns. Intermediate-term bonds may be best for some.
Over time, if the Fed steadily raises short-term rates, savings accounts and certificates of deposit would finally begin to sport more attractive yields. But don’t expect that to happen soon.
“We’re going to have to go through a series of rate hikes before savings accounts and short-term CDs are attractive again,” Heider said.