Dad, interest rates just went up. What do higher interest rates mean? Should that concern me? Does it even make a difference? It is something that only really matters to big players in the investment world?
Whoa, whoa, whoa! Let’s deal with the main question, and I’m glad you asked: What do higher interest rates mean? I think the answer to that will answer the others.
Interest rates have been flat for a long time. Many young adults today have never seen interest rates much above 0%. They have been flat since 2008, or for ten years. This is not what our generation is used to!
The reason for the incredibly low rates is to spur economic growth, especially in the real estate market. This is understandable, because what triggered the need was a real estate bubble that began to burst about halfway through 2008. It was catastrophic and many thousands of people lost their homes.
So… the powers that be decided they would give the markets a breath of air – aka, create another bubble – by dropping interest rates to the basement, which is where they have been for as long as you can remember.
This created a huge boost to the housing market by greatly reducing the cost of home ownership. By reducing interest rates to near zero, monthly mortgage payments were greatly reduced.
Let’s look at an example that is easy to see.
Let’s say you have a 300,000 mortgage, amortized over 30 years, at 3%. Your monthly payments would be $1,264.81. However, when you go up only 2%, which is FAR below historic levels, the payments jump to $1,610.46! Can you afford a $400 increase in your monthly mortgage?
It gets worse. If you go up to historic levels, somewhere around 10%, which they are sure to do, probably sooner than later, that payment becomes $2,632.71 per month! Are you prepared for that?
If you have credit card debt, rising interest rates should concern you, too. Credit card companies charge very high interest rates already, at least 6% above bank rates, even in these low interest times. Say your APR (annual interest rate) on your card is 10% and you’re carrying a balance of $10,000 (are you nuts??). If you pay $183.33 per month, the minimum monthly payment, it will take you 323 months to pay it off, and you will pay a total of $7,928.95 in interest. Wow!
However, if your rate goes up to 19%, the average historic level, your minimum payment rises to $258.33 per month, it will take you 344 months to pay it off, and you will pay more than $15,000 in interest!
Interest rates are rising and will likely continue to rise. The takeaway here should be to pay off any credit card debt you have, right now, and prepare for higher mortgage rates. If your mortgage term is almost up, you should be thinking about renewing early if you can, to lock in the low rates for as long as you can.
Finally, if a rate hike of a few percentage points will make your monthly payments impossible to pay, it might be a good time to consider cashing out and downsizing. Don’t get caught by higher interest rates!