With the arrival of spring, interest rates have begun to climb, making anything purchased on credit that much more expensive. In many ways, you can thank an improving economy.
When the economy crashed in the fall of 2008, the Federal Reserve responded by pumping huge amounts of money into the financial system. In a bid to save the big banks, which were for all practical purposes insolvent because of their vast holdings in "toxic" mortgage backed securities, the Fed loaned banks money at zero percent interest.
The policy appears to have saved the banks, which are profitable once again because there were able to borrow money at no cost, invest in bonds and pocket a nice return. At the same time, Congress approved huge expenditures to stimulate the economy. The result has been a recovering economy but a frightening accumulation of debt.
Fed Chairman Ben Bernanke sounded the alarm last week, warning in a speech that this huge increase in government debt threatens to eventually snuff out the economic recovery. The previous week U.S. bond auctions found fewer takers, forcing the Treasury to offer higher rates of interest.
As a result, mortgage rates are now heading higher. Freddie Mac reported last week that the average 30-year fixed rate mortgage has climbed from five percent to 5.2 percent, the highest rate in eight months.
Remember the 1980s?
For consumers over age 50, 5.2 percent still sounds like a very low mortgage rate. Those who purchased homes in the early 1980s have memories of double-digit interest rates. However, home prices were a lot cheaper back then.
A homeowner paying 12 percent on a $100,000 mortgage had a monthly payment of $1,029 with a 30-year fixed rate. Today, someone paying only 5.2 percent on a $200,000 mortgage would have a payment of $1,098. With more expensive home prices, buyers need today's historically low rates to make the payments affordable.
If interest rates are headed higher, and some analysts are predicting six percent by the end of 2010, then homes will be less affordable. That's bad news both for someone who wants to buy and those eager to sell. It may be especially bad news for sellers, since their home may lose even more value.
Interest rates on credit cards can also be expected to rise. The Fed reports the average credit card rate has now risen to 14.26 percent, the highest rate since 2001.
Fortunately for consumers, credit card companies are no longer allowed to raise interest rates on existing balances, just on new purchases. Unfortunately for consumers, most credit card companies jacked up those rates well in advance of last February, when the new law took effect.
For those who want to borrow money for any reason, the cost will likely be higher for the foreseeable future. The good news for consumers, however, is that household debt has been falling over the last two years. The Great Recession, more than anything else, has encouraged consumers to live within their means.
While rising interest rates are generally bad for the overall economy, consumers with money in the bank may stand to benefit. Interest on CDs and money market funds should continue to go higher -- which could help many seniors who have seen the interest on their savings shrink to nearly nothing in recent years.
