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For years, mortgage hunters, credit card holders and car shoppers haven't had to do a thing but sit back and enjoy the benefits of falling interest rates. Now the rate arrow is pointing upward -- and could stay there for some time.
Even though Alan Greenspan and Co. have increased the critical Federal Funds rates for the second time in two months, consumers needn't throw up their hands when it comes to bank products such as mortgages, credit cards and auto loans. The increase isn't instantly passed on to consumers in all cases, and rising rates make some alternatives worth considering. There's even a silver lining for savers, who might see CD and money market rates move up.
Here are some of the common products affected by an interest rate increase, and the best move that consumers can make with them now.
Fixed-rate mortgages: Mortgage rates probably won't move much. Because people expected rates to rise, mortgages already have. In fact, mortgage rates fell sharply in the past week because investors were no longer worried that the Fed would raise rates even more than 0.25 percent. The latest weekly survey of large lenders places the average rate for a 30-year fixed-rate mortgage at 7.87 percent.
Consumers might want to lock in the best rate they can get, so if you are actively hunting for a mortgage, this week's lull might be the time to lock in the best rate you can. If you've got a while to wait, some experts argue that this second 25-basis point Fed move actually might stabilize the markets and create a climate where long-term mortgage rates can slowly decline again.
Best move now: Know what you can afford in a home and a loan, and don't take a deal that won't work for your budget. If you're in for the long haul, rates are important, so look to buy it down by paying points -- or have the seller pick up the points, if you can swing it.
Adjustable-rate mortgages: As rates rise, borrowers may want to take another look at short-term adjustable-rate loans, especially if they don't plan to live in their homes for very long. Rates on those loans haven't gone up as much as rates on long-term mortgages, meaning they are a relative bargain. This week, for example, 30-year fixed-rate mortgages averaged 7.87 percent, while 1-year adjustables stood at 6.37 percent.
The ARM strategy is good only for a short period of time. These loans are called adjustable for a reason and will rise with interest rates after a specified introductory period, though most provide "caps" that limit how high they can go. Some hybrid ARMs are available, such as the 5/1 and 10/1 ARMs, which offer five or 10 years of fixed rates, then adjust annually in each succeeding year.
Best move now: ARMs become a smart choice for homeowners who need the cash flow -- particularly young or first-time buyers who expect their incomes to rise over time. Find an ARM with a rate that will stay put long enough to cover you until you move. Hang on to some of that cash, too -- if you can't move and interest rates really take off, you'll need enough money to refinance into a fixed-rate loan.
Credit cards: Experts say about 70 percent of all credit cards are variable-rate cards and most of those are linked to The Wall Street Journal prime rate. Because of this, people with variable-rate credit cards will see their interest rates increase very quickly by the same amount. On July 1, the day after the Fed announced its last 0.25 percent rate increase, credit card issuers flooded the newswires with matching announcements of their own quarter-point rate increases.
Best move now: For those carrying a balance on a variable-rate credit card, it might be a good time to pay down that debt before you end up paying more for the privilege. Also, consider transferring any balance to a lower-rate credit card, ideally, a fixed-rate card. A standard fixed-rate card averaged 13.29 percent on Aug. 24, while a variable card averaged 16 percent.
Car loans: The research shows that interest rates on new car loans tend to shift in lock step with the prime rate. If the prime rate increases by 25 basis points, expect rates on auto loans from financial institutions to follow suit almost immediately.
Not all car loans are tied to the prime rate, however. With interest rates expected to rise, the super-low financing deals available from captive finance companies of auto manufacturers such as Ford Motor Credit and General Motors Acceptance Corp. will look even better.
Best move now: If you're arranging financing for a new car, don't ignore dealer financing. Used-car loans are slower to follow the prime rate's moves, and may not change for a month or two. Even when a shift in rates occurs, it may be less than the prime rate swing.
Home equity loans: Home equity rates tend to follow The Wall Street Journal prime rate. Because it changes within a day or two of a Fed move, new home equity loan customers will start seeing higher rates shortly thereafter. Existing borrowers, however, won't see an impact at all because equity loans have fixed payments and rates. Equity loan rates average about 8.8 percent now.
Best move now: Shop even more carefully than before. Look for specials and deals that may cut closing costs, especially if rising rates slow business for lenders; the rate may be up, but your overall cost will be lower.
Home equity lines of credit: Both new and existing line of credit customers will pay more because almost all home equity lines of credit feature variable payments and rates like credit cards. The average rate on a line of credit is about 8.14 percent. A 25 basis point increase from the Fed (0.25 percent) would raise the rate charged on existing balances and new lines by the same amount within a few weeks, in most cases.
As a result, someone with $50,000 outstanding on a 10-year line would pay $614.33 a month, rather than $610.34.
Best move now: If it's variable, it's headed up. Pay down outstanding balances if you can. If you really need the cash, consider a 401(k) loan -- or stop and ask whether you have to have the money now.
CDs, savings accounts: This is where consumers find the good news. An interest rate increase created by the Federal Reserve Board will mean more interest earned on certificates of deposit and savings accounts.
Best move now: Shop around. If you have a CD maturing soon, roll it over into the shortest-term CD you can find. That way, you can look at the rates later to take advantage of any rate increase.
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