Living Columns & Blogs

Rates on the rise? Vacancies calling for big changes

The U.S. economy is poised for continued growth in the future. President Donald Trump’s pro-business stance will likely improve corporate earnings and continue to increase employment rates. However, no major economic policy revisions discussed during his campaign have been legislated, and the effects of budgetary changes will likely not be seen until 2018 or later.

Despite the uncertainty of these anticipated effects, a bright economic forecast always spurs rumors that interest rates will be raised.

The magnitude of such a raise, however, is unknown. Next year will see major changes at the Federal Reserve Board. Chairwoman Janet Yellen’s term ends in January, and three other governorships will end in spring 2018. That gives the president the opportunity to fill multiple vacancies, potentially altering the course of the Fed. While we are unlikely to see a return to the high interest rates of the ’80s, now is a good time for you to examine the potential effect of rising interest rates on your personal finances.

Small changes being discussed

Although the pace has been slow, the U.S. economy has experienced expansion over the past seven years. These improvements have led the Federal Reserve to indicate that they have planned a series of interest rate increases. There have only been four rate increases since the 2008 financial crisis, three of which occurred after the November election. According to Kiplinger, the Fed will probably raise rates at least 25 basis points twice in 2017.

Both Trump’s campaign and budget proposal called for additional infrastructure and increased military spending. Those moves could further reduce unemployment and increase demand for consumer goods. They could also lead to inflation, which would spur further rate increases. Avoiding a wage-price spiral requires a delicate balancing act between controlling inflation and increasing the cost of borrowing for businesses, homebuyers and credit card holders.

The Treasury is looking at using the bond market to hedge against rising rates, thus curbing U.S. debt. Nearly half of the federal bond debt will roll over in the next five years, needing replacement. The federal government is considering refinancing some of that debt for a longer period, thereby locking in today’s low rates, according to Bloomberg. It is reportedly considering issuing bonds that will take 50 to100 years to mature. They believe longer-term issues will be attractive because they will have higher yields than other “safe” investments — the longer term protecting against rising interest rates in the future.

What should retirees do?

Rising interest rates are a mixed blessing for baby boomers who either have already retired or plan to retire soon. The effect on their financial status in retirement depends on their current investment portfolio, debt and purchasing plans. Bank stocks generally respond favorably to rate increases, but stocks in other industries may take a hit if interest rate hikes cut into growth or profitability. On the bond market, new issues will offer better rates, but the value of older bonds will fall.

The rock-bottom rates in recent years hurt those invested in low-risk instruments like money market accounts and CDs, which are traditionally a significant portion of a retiree’s portfolio. Many eschewed investing in them altogether because of their low or nonexistent returns. Even if rates do increase, these financial instruments are not likely to return to yields of five or six percent for many years.

Interest rate changes will have the most impact on mortgages, credit cards and other debt. Increases trickle down to credit cards quickly. Paying balances down fast is important, particularly if you are still employed, so that debt is not a factor in a post-retirement budget. Additionally, reducing your debt will boost credit scores, which will help you if you need to finance a new car or home improvement down the road.

Mortgages are a concern for those planning to relocate in retirement. An increase in mortgage rates could discourage prospective buyers for your old home, and increase your costs for your new home. Even if you are not relocating, you may be adversely affected if you have an adjustable rate mortgage. The interest rate on an ARM will increase after a Fed increase, which can significantly affect your budget. The good news on ARMs, though, is most have limits on how often or how much the rate can increase.

The recent period of low interest rates rewarded homebuyers and other borrowers, but hurt and discouraged savers. Retirees need to be careful interest rate increases do not hurt their retirement plans. The best steps to take now are to minimize or entirely pay off your debt and make sure your investment portfolio is diversified to mitigate the effects of potential interest rate increases on your retirement.

Ash Toumayants is the founder of Strong Tower Associates, central Pa. retirement planning firm dedicated to helping clients in all stages of life prepare for retirement.