How to Handle Your Finances as the Fed Raises Interest Rates

Hoover Financial AdvisorsDecember 23, 2015

Financial Planning

This article was featured in The New York Times and discusses the recent increase in the federal funds rate.  This is a sign that the long recession and period of economic uncertainty is finally starting to carefully be put in our rear view mirror. Please read the informative article featuring a few general thoughts related to your finances. If you have any specific questions about your personal situation that you would like to discuss, please do not hesitate to contact our office (610-651-2777).

Article by: Tara Siegel Bernard

Now that the Federal Reserve has raised its benchmark lending rate, are you hoping that your savings account will start paying more than a mere fraction of 1 percent in interest? Worried that the monthly cost of your adjustable-rate mortgage might be about to rise sharply?

Well, you needn’t expect any abrupt changes.

The Fed has set in motion a gradual increase in the federal funds rate, which is the interest rate banks and depository institutions charge one another for overnight loans. But that rate, central as it is to the making of monetary policy, has only a wobbly effect on how banks and other financial institutions price certain loans and savings vehicles.

Consumers may be able to find slightly higher-yielding savings accounts and certificates of deposit, though the returns will still be meager. The cost of borrowing is expected to rise, but only slightly, with variable effects on what banks charge for credit cards, home equity lines of credit, adjustable-rate mortgages, auto loans and some student loans.

“If the Fed sticks to the script it has laid out for us, there should be little impact on consumers, at least through much of 2016,” said Mark Zandi, chief economist at Moody’s Analytics. The Fed’s “script” — which could easily change if economic growth, jobs and inflation deviate from expectations — calls for short-term rates to rise gradually to about 1 percent by the end of next year.

“Eventually, the impact on consumers will be more pronounced,” Mr. Zandi added. “If the Fed continues to tighten in 2017 as they now forecast, stock, bond and currency markets will come under pressure.”

But instead of trying to predict the near-term future, you would be wiser to ensure that your investments are well diversified and positioned for the long term.

Here’s what you can expect, whether you are looking for a place to save, invest or borrow:


Banks tend to raise interest rates on savings accounts when they want to attract deposits. But since they already have plenty of cash, according to Greg McBride, chief financial analyst at BankRate.com, consumers shouldn’t expect banks to immediately raise their rates, if they do at all.

“Banks are sitting on a lot of deposits, their margins have been under pressure and a rate hike is an opportunity to breathe a little,” Mr. McBride said.

Even if banks do raise rates, they are not likely to move quickly. Studies have shown that deposit account rates tend to rise more slowly in periods of rising rates relative to the pace at which they fall when rates are on the decline.

Today, the average bank pays a mere 0.08 percent for a savings account and 0.10 percent for a money market deposit account, according to BankRate.com.

Higher-yielding options, paying in the neighborhood of 1 percent, can be found at online institutions. Ally has an online savings account now offering 1 percent; Synchrony Bank’s savings account pays 1.05 percent; and Radius Bank offers 1.10 percent on balances of more than $2,500.

Certificates of deposit tend to move in tune with similarly dated Treasury securities, but they haven’t budged much in anticipation of an increase, which is atypical. “That indicates there will not be that much improvement in C.D.s,” Mr. McBride said.

The average yield on a one-year certificate of deposit is just 0.27 percent, compared with about 3 percent or higher in 2008, at the start of the economic downturn, according to BankRate.com. Better yields are likely to be found at online banks.

Money market mutual funds generally invest in low-risk investments, including short-term government securities and asset-backed commercial paper. Since securities held in these funds tend to mature, on average, within 40 days, it should take about that long for yields to rise (as the different securities mature and the money is reinvested at a higher rate), said Debbie Cunningham, chief investment officer of global money markets at Federated Investors.

Fundholders can generally expect yields to rise to roughly 0.35 percent from about 0.10 percent, she said, though it will vary by fund and provider.


Bond investors get nervous when interest rates tick higher because bond prices tend to fall in response. When rates increase, the price of existing (and lower-yielding) bonds drop because investors can buy new bonds issued at higher interest rates.

Since the Fed signaled its plans for some time, the bond market had largely priced in the rate increase. “The average person should feel pretty good that today’s rate reflects all of that information,” said Fran Kinniry, a senior investment strategist at Vanguard. “It’s probably going to be a big yawn.”

To get a sense of how your own bond funds may react to rising rates, take a look at its duration, which generally measures how long it will take to receive all of your money back, on average, from interest and your original investment.

If interest rates rose a full percentage point, a fund like the Vanguard Total Bond Market Index Fund, which has an average duration of 5.8 years, would decline by about 5.8 percent. But since the fund also pays investors income — it has a yield of about 2.26 percent — it would post a total loss of only about 3.5 percent. And the yield would eventually increase, helping to mitigate the loss.


Many people think mortgage rates are tied to the Fed’s action, but there is no direct link. The Fed controls a key short-term rate, while 30-year fixed-rate mortgages are generally priced off the 10-year Treasury bond, which is influenced by a variety of factors, not just short-term rates but also the outlook for inflation and long-term economic growth here and abroad.

Still, some home loans are more directly influenced by the Fed’s action, including adjustable-rate mortgages and home equity lines of credit, which generally carry variable rates.

Rates on 5/1 adjustable-rate mortgages — or those with a fixed rate for five years, which then adjust each year thereafter — have moved up in recent weeks but are still around 3.14 percent, according to HSH.com, which tracks the mortgage market. That compares with rates of 30-year fixed mortgages, which averaged 4.04 percent the week ending on Tuesday. (That rate includes a fee of 0.17 percent of the mortgage amount. The adjustable rate includes a fee of 0.10.)

Is it time to refinance? Homeowners with adjustable-rate mortgages who are already facing annual readjustments, or who expect to soon, should consider refinancing into a fixed rate now, financial advisers said. For those with active adjustable mortgages, Mr. McBride said, “the cumulative effect of what the Fed may do over the next couple of years could be significant.”

But borrowers with A.R.M.s who still have a fixed rate locked in for several years may want to take a wait-and-see approach. “It is not as simple as getting the fixed rate, putting it in a drawer and forgetting it,” said Keith Gumbinger, vice president of HSH.com.

Interest rates on home equity lines of credit, which are expected to rise roughly in line with the Fed’s increases, are likely to increase to about 5.5 percent on average in the next year or so. Borrowers can ask to lock in a fixed rate for their existing balance, but they will probably pay at least 6.20 percent, said Mr. Gumbinger, so it may not make sense just yet, depending on the size of your loan balance and how long you expect it will take to pay it back.


Credit card holders with variable rates — averaging around 15 percent today — can expect their rates to rise within one or two monthly cycles.

Some card issuers are still offering zero percent introductory rates, sometimes for as long as 18 months, so now is the time to take advantage. “Grab those zero percent offers while you still can, and give yourself a window to repay that debt,” Mr. McBride said.

Similarly, auto companies are expected to offer incentives to buy that should help keep rates low for borrowers with good credit ratings.

As for student loans, federal loans carry a fixed rate, but the crop of new loans reprice each July based on the 10-year Treasury bond. Private student loans generally base their fixed and variable rates on the Libor index, which generally tends to track the Fed funds rate pretty closely.

For a link to the full article on nytimes.com please click here.

Thank you and Happy Holidays!!