I know it’s hard to believe with Donald Trump in charge, but one of the responsibilities of the federal government is keeping the economy from tanking.
It does that most directly through the Federal Reserve, the central bank of the U.S., which manages the gradually increasing cost of everything by tweaking the interest rates everybody uses. That’s called inflation, and it’s why 10-year-old Donald Trump paid 10 cents for McDonald’s french fries but pays $1.79 today. (Assuming he orders medium and not yuge.)
If the Fed didn’t control interest rates, inflation would spiral out of control and french fries might cost $13,900 instead. That’s how you get situations like the 100 trillion dollar bill in Zimbabwe. (Which was not worth enough to buy fries by 2015. Now it’s worthless.)
So it’s important, especially as the economy recovers, to keep inflation in check. The Federal Reserve’s goal is about 2 percent inflation per year, and it just raised interest rates for only the third time since the financial crisis. It plans to probably do it twice again this year, likely in June and December, and keep doing that for the near future.
It’s good news for the economy, but it’s not always good news for everyone — especially people in debt. So let’s take a quick look at how rising interest rates could affect various groups…
Bad news for these folks
Rising interest rates should trigger alarm bells for people with credit card debt. Here’s why.
Used to be there were a lot of fixed-rate credit cards. Nowadays, most have variable interest rates — and the big variable is the Fed rate.
The current Fed rate (or federal funds rate) is 1 percent. By the end of the year, it’ll likely be 1.5 percent, and working its way up to 3 percent by 2019.
Credit card companies set their “prime rate” — the ideal interest rate, reserved for people with the best credit — a few percentage points about the Fed rate. So it’s now 4 percent. Then they set your card APR off the prime rate plus a margin they add based on your creditworthiness — the worse your credit, the higher your interest rate.
So if you’re carrying a balance on your credit card, you’re going to owe more and take longer to pay it back as the economy continues to improve. Credit card debt has among the highest interest rates, so you don’t want it getting any worse.
Aside from credit cards, people with home equity lines of credit should expect higher interest rates. Those are also tied directly to the prime rate, and people with high balances could be surprised within a couple months by higher payments.
Homeowners with adjustable-rate mortgages — which have been declining since the recession, fortunately — should also be concerned about higher rates. According to Bankrate, they might expect to spend as much as $60 more per month on a $200,000 mortgage pretty quickly.
Fixed-rate mortgages will probably not move much, since they tend to move more closely with inflation itself. But rates do try to price in future rate increases, so they are likely to gradually rise, making it better to buy sooner than later. That would place them squarely in the next category…
These people should start paying attention
Federal student loans have fixed interest rates, so if you already have a loan you don’t need to worry about any changes unless you refinance or consolidate your loans. (Or Donald Trump changes things.) If you have a private student loan with a variable interest rate, you have a lot more to worry about. If you’re a student or parent looking at taking out new student loans, you should know that federal student loan rates are tied to the 10-year Treasury rate, not the federal funds rate that’s going up now. But the Treasury rate factors in expected interest increases, and will start ticking up over time, too.
What about people with auto loans? Debt.com founder Howard Dvorkin argued in January that Trump will oversee a recession triggered by subprime auto loan debt. Again, people with variable rate loans should be most concerned, but the impact for both fixed and variable loans will be much lower for people with shorter terms. Short-term loans come with lower interest rates, and plus the faster you pay off the debt, the less you have to worry about rising rates.
Small businesses are also affected by rising interest rates. Their growing pains will get more painful as the cost of borrowing capital increases. Profit margins for businesses in general, both large and small, tend to go down with rate hikes. (Except in the banking industry.) It’s especially hard on companies that are just trying to establish themselves and don’t have stashed profits to fall back on.
In a good way for a change, savers should start paying attention. Both personal savings and certificate of deposit accounts start getting better returns as interest rates rise. Right now, they’re not much to look at — saving accounts average 0.11 percent interest and one-year CDs are about 1.24 percent. Don’t expect them to go up quickly, but they’ll start looking better than they have in years during Trump’s term. But if you have debt, you need to focus on that first — because those rates rise far faster and you’ll lose any gains you make by saving here.
It’s not clear if interest rates affect these people
Now we get to the stuff that interest rates have an indirect, and sort of unpredictable, effect on. Chiefly among them is Trump’s top priority: jobs.
The Fed raising rates tends to put the brakes on the economy in order to slow down inflation — borrowing gets more expensive, so businesses become more cautious about expanding and hiring slows down. They focus more on keeping what they got and slow, steady growth. That could happen here, but Trump has big ideas about jobs and a lot of opportunity to fill vacancies in the Fed that may shift policy toward job growth rather than controlling inflation.
For the same reason, it’s hard to say what will happen to investors. They certainly care about business performance, and the stock market sees slow inflation as a good thing and a sign of a healthy, stable economy. But if there’s even a hint of Trump taking us in a strange new direction, things could go south. Or maybe the market is already tired of reacting to Trump’s every whim and trying to guess what will happen, and they’ll just ignore him. Who knows?
Another big question mark for renters. As mortgages get more expensive, theoretically rents will go up as more people compete for the same space. Rental companies also have to pay more to buy and renovate, so their higher borrowing costs may be passed onto renters if they can get away with it, too. But people don’t buy or sell homes based exclusively on interest rates, and a gradual return to a normal rate might not have a dramatic impact this time around.
One more wild card for today: Anybody who relies on federal government services for their livelihood. For instance: Federal workers, veterans on benefits, small businesses with loans, tourism and travel companies, people with disabilities.
Higher interest rates affect the money the federal government borrows too, which boosts the national debt. And when it gets to the limit set by Congress, the federal government literally shuts down. As we approach the limit, politicians play absurd, childish games of chicken to try and get things they want.
In 2013, Republicans forced the federal government to shut down for two weeks over Obamacare repeal. Not only is that hugely expensive to the government and the economy, but it directly affects many regular people. Guess what? We’re right up against the limit yet again.
Article last modified on May 10, 2017. Published by Debt.com, LLC .