Interest Rate Hike Will Hurt Borrowers
Kristi Lee knew it was coming. But the Federal Reserve’s move Wednesday to hike its benchmark interest rate a quarter-point was unwelcome just the same.
Lee, a 29-year-old intern at Cleveland Chiropractic College in Los Angeles, is graduating next month with a hefty $180,000 in debt from her eight years in college. She’s worried that the cost of her variable-rate student loans will soar before she can start repaying and lock in a fixed rate.
A quarter-point hike would swell the monthly payment on Lee’s loan by about $20 under a typical payoff plan. If the Fed continues raising rates, as widely anticipated, the payment will just get bigger.
“It’s pretty scary,” she said.
While a series of small interest rate hikes probably won’t deal a severe blow to the economy or consumers, it will make life a little more expensive for many people.
The hike Wednesday is expected to immediately boost costs for home equity lines of credit, variable-rate credit cards and some other personal loans.
Nearly all of those loans are tied to the prime rate, which moves in near lock-step with the Fed’s benchmark overnight lending rate for banks.
And many major banks hiked the prime rate to 4.25% from 4% on Wednesday only hours after the Fed announced its hike.
Still, the balances on the loans held by those banks generally are low enough to make the hike appear relatively insignificant.
At Wells Fargo Bank, for example, the average outstanding balance on a home equity credit line is $40,000, said Doreen Woo Ho, president of Wells Fargo Bank’s consumer credit group. So a quarter-point hike, she said, will cost the average borrower about $8 a month.
Credit card terms vary widely, but with the average individual credit card debt under $8,000, experts don’t see the rate increase as a significant factor.
The biggest effect could be on home buyers.
The cost of home mortgages started rising in March in anticipation of the Fed’s move, which had been telegraphed to investors for months. That makes it more costly to buy a house -- a disappointment to renters who were hoping to break into Southern California’s hot housing market.
“This is going to set me back,” said Joanna James, a Los Angeles insurance clerk who wants to buy a first home. “I’ve been talking to a Realtor about buying a house. This just makes it more expensive.”
On a longer-term basis, consumers with student loans and adjustable-rate mortgages may also pay more. But those changes are likely to take more time.
Student loan rates adjust just once a year based on Treasury bill yields set at the final auction in May.
Those rates hit historical lows this year, and student loan rates are now fixed at either 2.8% or 3.4% (depending on the status of the loan) until July 1, 2005.
Borrowers who are able to consolidate their loans before that date will be able to lock in today’s rates. But those who are still in school or haven’t found a job and want to postpone making payments, like Lee, are stuck with their variable-rate loans.
Consumers with adjustable-rate mortgages may also face higher rates in the future. Many of these loans are insulated from immediate changes because of adjustment periods -- some of these loans adjust just once annually, or less. And other ARM borrowers are helped by slow-moving mortgage indexes.
As the Fed was hiking rates on Wednesday, for instance, the 11th District cost of funds -- a popular index for some types of adjustable-rate loans -- was falling. The so-called COFI dropped to 1.708% from 1.802% the previous month. Still, over time, these loans could prove far more costly.
Not everyone was lamenting higher rates.
Rate hikes can help savers by boosting the interest rates paid on bank accounts, certificates of deposit, Treasury bills and bonds, as well as money market mutual funds and other interest-sensitive investments.
Already, interest rates on one-year certificates of deposit have edged up to 1.5% from 1.1% in March, said Greg McBride, financial analyst with BankRate.com in North Palm Beach, Fla.
That’s still a modest yield, to be sure, but it’s encouraging to retirees like Frank Corradi Jr.
“I think it’s a good thing,” said Corradi, who lives in Point Pleasant Beach, N.J. “People whose income depends on interest rates have savings accounts and CDs that are paying practically nothing. I’m getting less than 1% on savings.”
Corradi was hopeful that the Fed’s move was just the start of a rising rate environment that could be beneficial to savers like him.
