For many consumers, it’s easy to hit the snooze button when it comes to talk about the Federal Reserve possibly raising short-term rates by one-quarter of 1 percent in mid-December. Who cares?
Throughout last year and this year, we heard dire warnings that the Fed would be driving up rates, but the Fed barley budged. We had only one small rate hike in December 2015.
Consumers would be wise, however, to prepare for the day, maybe as soon as early next year, when higher rates could cut into monthly budgets. That’s especially true for those who have an adjustable rate mortgage or a variable rate credit card.
On a $200,000 adjustable rate mortgage, a quarter-point rate hike could easily add about $30 to a monthly payment. And the payments would climb further should the Fed move to raise rates again.
Many consumers have fixed rate mortgages these days. The adjustable rate mortgage market isn’t huge. But if you’re the homeowner ultimately facing paying an extra $60 or $90 a month over time, a couple of rate hikes would whack your wallet and, maybe, influence where you go out on date nights or how much extra cash you have to pay off student loans.
“Consumers are certainly exposed to a rate hike,” said Nidhi Verma, TransUnion’s senior director of research and consulting.
How vulnerable someone’s pocketbook is, though, depends considerably on how much of their debt is tied to adjustable rate products – including adjustable rate mortgages, variable rate credit cards, home equity lines of credit or other variable rate loans, according to research by TransUnion.
TransUnion found that up to 68 percent of credit-active consumers – or up to 92 million consumers – would experience some level of monthly payment shock as the direct result of an interest rate hike.
Consumers who pay their credit card balances in full each month wouldn’t be impacted; the same is true for consumers with some credit cards that have already hit the interest rate caps, Verma said.
The average hit of a 0.25 percent rate hike amounts to about $6.45 a month, if you spread all the borrowing on the variable rate products, based on TransUnion’s study. It looks pretty small. But the real cost to individuals will depend heavily on their own types of loans and how much they’ve borrowed.
TransUnion’s research indicated that about 9.3 million people are on the financial edge and would not be able to absorb the increase in monthly payments that would follow a quarter-point rate hike.
Given that the Fed is expected to move gradually, though, some consumers would have more of an opportunity to make some adjustments to prepare for a rate hike and deal with the payment shock.
Two key strategies: Pay down that credit card debt – and refinance that adjustable rate mortgage to a fixed rate, if you’re planning to stay in the home for the next several years.
If you’ve taken out a $100,000 or $200,000 mortgage with an adjustable rate, the impact of a rate hike would be greater than borrowing a few thousand on a variable rate credit card.
“An interest rate hike has an inconsequential effect on credit card payments because of the ability to pay the bare minimum,” said Greg McBride, chief financial analyst for Bankrate.com.
“But your debt repayment efforts go into a progressively stiffer headwind as interest rates go up.”
A quarter-point rate hike would add just a buck each month to the minimum payment on a variable rate credit card, if you have $5,000 of debt on that credit card, McBride said.
But those higher rates would mean that it could take you two extra months to pay off a $5,000 debt on a credit card – and you’re looking at an extra $107 in interest costs.
Two quarter-point hikes add $2 to the minimum monthly payment. But it could take you an extra four months to pay off that same $5,000 debt and an extra $216 in interest.
Some options: It can be savvy to find no-interest credit cards now – and pay down the debt as quickly as possible to insulate yourself from higher rates, McBride said.
When it comes to adjustable rate mortgages, experts say, now could be the time to refinance, especially if you plan to stay in the home for the next five or 10 years.
On average, adjustable rate mortgages accounted for 4.6 percent of mortgage applications in August, according to the Mortgage Bankers Association.
“We tend to see borrowers lock in a fixed rate when interest rates are low and so the share of (adjustable rate mortgages) tends to fall in a low-rate environment,” said Lynn Fisher, vice president of research and economics for the Mortgage Bankers Association.
Borrowers may find it hard to pass up 30-year fixed rate mortgages now going for around 3.375 percent or 3.5 percent.
Bob Walters, chief economist and executive vice president of the capital markets group for Quicken Loans, said consumers can look at the type of adjustable rate mortgage they have and see how they might be hit by higher rates.
Some adjustable rate mortgages can adjust two times a year; others once a year.
Some adjustable rate mortgages offer a fixed rate for five years or a fixed rate for seven years. So if a five-year adjustable is still protected under that fixed rate period, the monthly payment would not bump up during that time.
Walters said many consumers have been refinancing to take advantage of ultra-low mortgage rates, which fell significantly after Britain voted to exit the European Union in June.
Many economists and market watchers expect what’s called a “slow lift off” in interest rates in the coming year – so that could mute some payment “shock” in the next year or so. But locking up low rates soon could still be a smart way to brace your wallet for higher rates ahead.
Susan Tompor is the personal finance columnist for the Detroit Free Press. She can be reached at email@example.com.