Last week the federal reserve announced their interest rate hike plan for the year. After many months of uncertainty, it finally looks like there is some stability in their plan. This is the best thing we could have hoped for, a laid out plan to curb the uncertainty. Even though it is not the most appealing plan, its a plan none the less.
Their plan is to do 7 interest rate increases over the next year. Each interest rate increase is .25% or 25 basis points. They did their first interest rate hike last week at their announcement. This plan will raise the federal reserve interest rate by 1.75% this year. It is quite the HIKE! However, this can be seen as a good thing. By them raising interest rates, it should drive demand down for borrowing, which should help curb inflation. We all know inflation is at an extreme high, last year the inflation rate was 6.7% when our target is 2%. Already, this February, inflation has sored to 7.9%.
This would be good to decrease inflation, so the cost of living does not sky rocket, which would cause a lot of middle class individuals to enter lower class/poverty. So, what does an interest hike mean? Essentially, the bank has to pay more money to get money. So, the bank borrows money from the federal reserve, if they increase their interest rates, it now costs more for them to borrow. Which in turn, they will charge us the consumers a higher interest rate to cover their increased fees. We will see this in credit card interest rates, home mortgages, consumer loans such as cars, personal loans, home equity lines of credit, and much more. Our payments for these things will then increase because we are paying a higher interest rate on our products.
How the interest rate increase affects home buyers. The interest rate hike may cause the 10 year treasury yield to increase. The 10 year treasury yield is one of the safest, yet lowest returning note, which is essentially a loan to the U.S. government. As long as this rate stays above the inflation rate, investors will not lose money. So, right now, with inflation being so high, this is not looking like a safe investment. If this 10 year treasury yield increases though, it is going to make housing prices increase because instead of investing in real estate, investors could put their money into this note which is returning a higher interest rate then previously. If interest rates for homes increase, their is a potential for home prices to decrease. They say for every 1% the interest rate goes up, you can expect to see a 10% decrease in housing costs. They do this because housing prices tend to be about monthly payments. “So, what can we afford.” So, if interest rates increase, prices need to decrease to allow for a similar monthly payment.
I do think with inflation at such a high, uncertainty in the market, uncertainty in the world, and the devaluation of the dollar, prices for homes will not plummet. They may decrease a little bit but houses are such a safe asset right now, I would not be surprised to see their prices stay elevated. Also, when interest rates increase, stocks tend to decrease. Stocks are one of the biggest investment tools, if not the biggest investment tool in the U.S. So, if we knew they were most likely to decrease (based on previous history with federal reserve interest rates rising and stocks decreasing), then real estate is looking like a safer asset to park extra money in.
On the same topic of stocks, margin (which is essentially a loan to invest in stocks with) interest rates may increase. If margin interest increases and it costs more money to have margin to invest, it will make your margins for profit even slimmer. If the market continues to decline, like it has for months, your margin may be getting closer to the debt to equity threshold and you may start getting your margin pulled, which could mean a loss of money for you.
This may be a good time to start paying off some of your debt. Consumer loans, student loans with variable interest rates, margin, any variable interest rate. Things that have a fixed interest rate, like a fixed mortgage or an automobile, I would not worry about. Things like credit cards, lines of credit, student loans, or personal loans with variable interest rates, I would be looking to pay them off.
I hope this helps, please leave a comment on your take on the interest rate hikes. If you want to hear an in-depth talk on this, check out our YouTube Video or our podcast on interest rate hikes.
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