What a Fed interest rate hike could mean for you
Since the Great Recession started eight years ago, the Federal Reserve has kept its benchmark interest rate near zero as a way to strengthen the economy. However, according to the minutes from an October 2015聽gathering of Fed officials, a rate increase is likely in December. A decision should be announced Dec. 16.
Any economic change聽brings聽good news and bad news. Here聽are聽a few parts of your financial life that might be affected by a rate increase:
Home sales
Rising interest rates generally put downward pressure on the demand for homes and home prices, at least in the short term. So if the Fed raises rates, you may not see very many聽鈥淔or Sale鈥� signs in front yards for a while.
This might make you nervous if you鈥檙e聽planning to sell your home soon. After all, most people鈥檚 wealth is in their homes. But a small rate increase doesn鈥檛 necessarily mean that the housing market will plummet. If rates stay near their historic lows, many prospective buyers will realize that they still can afford a new home and will.
Bonds
Interest rates and bond prices move in opposite directions. When interest rates go up, bond prices go down. If you鈥檙e thinking about selling your bonds before they mature, higher interest rates will work against you. However, if you鈥檙e holding those bonds until maturity, you can sleep well. You鈥檒l still collect interest, though at a lower rate than you would on newer-issue bonds.
If you own shares of a bond mutual fund, a rate increase will more than likely cause those shares to temporarily drop in value. But fund managers will begin to buy higher yielding bonds, which might help soften the blow. For the future, consider this strategy used by聽proactive bond fund investors: Stay out of long-term bond funds, which take the biggest beating when rates rise.
Stocks
The effect of rising interest rates on聽stock prices is a little murkier than its effect on聽bonds. Stock prices generally decrease when interest rates go up, but that鈥檚 not always the case. If we鈥檙e in an economic expansion when rates rise, more often than not, stocks go up. Conversely if the Fed is raising rates to 鈥渃ool down鈥� an overheated economy, stocks tend to go down before rebounding. If you聽, their聽rates will increase immediately if聽the Fed raises the benchmark.
Hiring and income
By keeping rates low, the Fed hoped to聽encourage聽economic growth, which is often measured by employment numbers. If the聽Fed does raise rates, it would be a聽signal that employment is recovering, and firms are hiring.
More hiring means more income for everybody. And higher incomes tend to solve other problems, including low demand for housing. Even though a rate hike would mean that it costs more to borrow money, higher incomes help offset these costs.
Higher incomes also mean more spending. More spending means that聽workers keep their jobs. And the cheap prices that we鈥檙e seeing at the gas pump put even more money into consumers鈥� pockets that they鈥檒l want to spend.
In the Fed鈥檚 words, it might be time for a rate increase because there鈥檚 been a 鈥渢ightening of the labor market.鈥� In plain English, that means more hiring and less firing. Ultimately, the Fed鈥檚 decision reflects growth聽鈥� which means that, for you,聽the good news of a rate increase should hopefully聽outweigh the bad news.
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