Interest Rate Increase
You might have heard the alarm bells going off with interest rates increasing. Yes, they’ve been historically low since the 2008 economic crash. Most people seem to have forgotten that we have an interest rate at all. Mainly because savings-type accounts earn pennies. Interest rates do not make for the most exciting chat topic. I have a friend that rolls her eyes every time I talk about the economy. Little does she realize that the interest rate has many tentacles.
We’ve been on an interest holiday since the Great Recession. Mesopotamians paid higher rates in 3,000 BC.
See Business Insider’s article. 5000 Year History of Interest Rates 2016/12
Interest is the cost of borrowing money and almost everyone uses it one way or another. Small businesses pay interest for short-term loans to float their payroll, banks lend money to each other, large businesses invest their idle cash to earn interest. The most obvious is credit card and personal loan interest paid by consumers.
The Federal Reserve controls the economy by regulating the interest rate. They raise or lower the interest rate to stabilize consumer prices or maintain a labor market that employs the most citizens. They can contract or expand the flow of money by adjusting the cost of capital.
The interest rate triggers some hidden changes as well. Mainly the general happiness level. That seems fairly broad, but it’s not, if you look at the far-reach of the cost of borrowing money. Interest costs get baked into product costs just like rent, payroll, and utilities. In addition to everything costing more, the latest fear factor is that the housing market’s going to drop because of an increase in mortgage rates. Any consumer loan payment is going to increase. The reason why it’s major news is that we’ve basically been on an interest rate holiday for the past 10 years.
New purchases require more thought and consideration than before, for both consumers and businesses.
Here’s why. Many auto loans are hovering around 3%. When I purchased my first car in 1986, my loan rate was 9.9%. Comparing 1986 to now, on a $10,000, 5-year loan, the difference in the monthly payment would be $32, an 18% difference.
At 3%: $180
At 9.9%: $212
That doesn’t sound like much per month, but over the course of the loan, the borrower is paying almost $2,000 more for the same purchase. That’s significant.
The same occurs with a home mortgage, only on a larger scale. The housing market is directly impacted as higher mortgage payments make home buying out of reach. As interest rates are increasing, there is typically a stampede to close on fixed mortgage rates. Adjustable mortgage rates should be avoided entirely when interest rates are in the swelling phase. The initial payment may be affordable, but as the rate adjusts, usually after the teaser period, payments become dangerously high leading to financial stress and, possibly, foreclosure.
Stocks and bonds are affected too. An interest rate increase triggers insecurity with the economy, giving emotional investors a reason to sell. This is tied to a business’ net profits on two levels. Consumers tend to buy less, directly affecting the top line, revenue. Because businesses are paying more for equipment and materials, the business’ bottom line is less, therefore, earnings per share is lower.
As for bonds, interest rates being earned on currently owned bonds may not be competitive with a higher interest rate of a no-risk account, such as a savings account.
Example: An investor buys a 10-year bond and earns 4% in interest income. Within the 10 years, the interest rate creeps up to 6%. The investor’s bond is locked in at 4% when s/he could be earning 6% in a savings account. The bond, like any other financial instrument, is subject to risk. A plain vanilla savings account has no risk. That’s why the value of the bond goes down. The investor is earning 2% below what they could earn if their money was invested elsewhere.
If the bondholder wants to sell their bond before the maturity date, they will most likely sell at a loss, due to the lowered value of the bond.
The winners are – the credit card companies and fixed income earners.
For my friend that rolls her eyes at me, she fails to realize how much an interest rate creep is going to affect her son. Less hiring and higher costs for everything may delay or stifle his ability to get out on his own.
Higher interest rates are back
I consider interest to be throwing money away. When you have no money, you have no choice but to borrow. As you move through life, building up your earnings and assets, your goal should be to avoid paying interest as much as possible.
Why You Need A Will
If your last dying wish is to cause discord among your family members, and you feel a grin coming on at the thought of watching your family members rip each other’s guts out, then stop reading right now. Otherwise, my next piece of advice is to write a will. When you write a will, you alleviate the potential for a family feud.
Aretha Franklin and Prince both did not have a will. As a result, Aretha’s estate is going to be tied up in court for several years. While family members fight over every last dollar and remnant, the winners will be the lawyers.
You need a will if you own assets and if you have children.
Name beneficiaries carefully and make sure they’re updated.
Avoiding probate court
Probate assets are assets that become homeless after the death of the owner. They have no legal title, and if they have not been named in a will, they end up in probate court. Cue the legal eagles.
Assets that have a beneficiary designation avoid legal interference. By having a specific beneficiary designation, they get in the fastlane to their new owner by passing automatically upon death.
Accounts that have a named beneficiary, i.e., non-probate assets, transfer ownership immediately. These accounts are IRAs, 401(k)s, joint accounts, trusts, etc. The creator of the account is required to name a beneficiary on the application.
By ensuring that assets without a named beneficiary are appointed to a new owner via a will, you save time, aggravation, and costs to your survivors.
Again, name beneficiaries carefully and make sure they’re updated. People die, move away, or lose contact. Review your beneficiaries and revise, if needed.
Join me next time when I discuss the best gift you can give your children.