On 14 June 2017, the Fed announced a 25-basis point increase to the FFR. This has far-reaching implications for the banking and financial sectors, notably for individuals and businesses applying for loans. Consumers understand the implications of increased interest rates. Higher interest rates increase the overall cost of a loan by a figure greater than the fed funds rate increase. Over time, the interest-related charges on loans add up. This makes it important to understand why decisions taken by the Fed matter.
Households with credit card balances, student loans, automobile loans, savings accounts, home mortgages, personal and business lines of credit will be affected by recent changes. It is estimated that the 25-basis point rate hike to the federal funds rate will increase the repayments on credit card balances by as much as $1.5 billion through the remainder of 2017. This is substantial, and it is imperative that businesses understand the wider implications of increasing interest rates. The terms and conditions according to which individuals and businesses are granted access to lines of credit are also changing in the current economic climate.
The Fed’s Wheels Are Starting to Turn
The June rate hike marks the fourth time that the Fed has increased interest rates since December 2015. It took the Fed 7 years to act, but ultimately monetary policy has shifted from quantitative easing to quantitative tightening. In the space of 18 months, 4 rate hikes have kicked in and the Fed is accelerating the pace of interest rate increases towards its objective of 3%, perhaps even 4% by 2019.
The broader implications of this policy may not have hit home yet with many individuals and businesses, given that the hikes have been modest. Perhaps the best way to illustrate the importance of increasing interest rates is found on the impact on individual components such as mortgages, automobile loans, credit cards, and business loans.
How Will Mortgages and Car Loans Be Affected?
Mortgages typically move in lockstep with the yields on treasury notes. In 2012 the typical rate on a 30-year mortgage was 3.50% – today it’s 4.04%. As interest rates rise, adjustable-rate mortgages will move in unison. The better option for new homeowners and impending homeowners is a fixed-interest rate mortgage, especially in an era of steadily rising interest rates.
Those most at risk are homeowners with adjustable rates, which will likely rise within the next two years towards 5% or 6%. While the nominal increases in monthly repayments are minimal, they do add up over time and become substantial repayments. Fortunately, homeowners can counter escalating rates by locking in fixed rates with their banks and home loan providers.
Much the same is true with car loans. Vehicle financing forms an increasingly important component of the average US household debt. For every 25-basis point increase in the federal funds rate, $6 more will be paid on a $50,000 car loan. Presently, the typical 4-year used car loan interest rate is 5.07% and the 5-year car loan rate for new cars is 4.42%. Much like mortgages, you can expect these rates to increase – regardless of personal or business usage.
Work to Pay off Your Credit Cards Quicker
Credit cards differ from home loans in the sense that they are usually associated with variable interest rates. Whenever the Fed raises interest rates, credit card companies smile all the way to the bank. That’s why it is important for businesses and individuals to pay down credit card debt as quickly as possible in an era of rising interest rates. Consider that $10,000 of debt equates into an additional $25 per annum.
According to the experts, the recent 25-basis point rate hike will raise credit card company revenues by $1.5 billion in 2017. Overall though, all 4 interest rate hikes of 1% in total will raise credit card fees/payments by $6 billion this year. That means every 25-basis point rate hike is worth $1.5 billion to the credit card companies.
What about Loans for Businesses?
The current unemployment rate in the US is hovering around 4.3% – considered a full employment level by the Fed and economists. With tightness in the job market, there is very little slack available. Loans for businesses are a viable option when it comes to expanding operations, or acquiring a safety net for possible future economic downturns.
There are many ways to apply for short-term business loans, and many businesses will qualify, provided that have been in operation for six months or more. Fortunately, bank and non-bank providers facilitate business loans. The requirements of non-bank providers are significantly less stringent than banks. There is very little paperwork to contend with, and most decisions are made online.
A credit score of at least 500 will typically suffice, and annual income levels of $100,000 minimum will qualify most businesses for these types of loans. With increasing interest rates, it is natural to assume that the costs of business loans will increase accordingly. The interest rates for these types of non-bank loans can start at 10%, and the loan terms can run from 3 months through 18 months. On the plus side, approvals can take just 1 day for non-bank loans provided the client meets the requirements.