While most of us will read the headlines about rising interest rates; many will just give it a cursory glance. With terrorism and ISIL attacks on the rise and massive layoffs in the oil and energy industries (and in retail too, Macy’s just announced massive job cuts, Trump gloats); the actions of our Federal Reserve Bank easily go unnoticed. However, the decision of the FED to raise interest rates will affect nearly every American. Some may actually benefit from an increase in interest rates (e.g. retirees living on a fixed income) but most Americans will be negatively affected. The negative effects are especially dire for employment and small businesses.
The small business still reigns as king of creating new jobs in America. More Americans, baby boomers and Gen X work for a small business than a large corporation. And when the small business owner is impacted, so are their employees and those looking for a job. While most of us start to snooze when we hear pundits on TV droning away about “interest rates” in an economic policy context, one must realize that the direction of interest rates are critical to avoiding a recession.
Rising interest rates will negatively impact all facets of the American Dream.
Rising interest rates typically will hurt the stock market; and this is happening now in 2016. This is the worst beginning of a new year for the stock markets in history! Thus, with stock markets around the world and US stocks today plummeting, your 401k, IRA and Roth IRA could suffer losses. As many local Dallas and Ft Worth baby boomers nearing retirement have upped their 401k max contribution playing catch up with their investments, this is a tough pill to swallow. Michael Ham, founder of My Money Track says his best advice is to seek the help and guidance of a professional expert or advisor to review how much exposure to the US stock market your money may have.
Even the best financial planning cannot always ensure financial freedom; unless one has made the wise decision previously to use only insured or protected growth investments. Even after this market malaise, it is not too late to protect your portfolio against more losses in the future.
However, the biggest loser with increasing interest rates is real estate; in particular, home values. Due to crazy low-interest rates and “cheap” money…
Real estate values in nearly every market in America have exploded and reached “bubble” levels
Just as they did in 2006-07, the “NINJA” mortgage loan (acronym for; No Income, No Job Applicant) has reappeared in “hot” markets such as San Francisco. And even in lukewarm markets, one may again apply for “zero money down” mortgages again! However, when the real estate bubble burst this time, as it did fueling the 2008 financial crisis, we won’t be able to use the primary weapon to soften its devastating blow.
Recall that 30-year mortgage interest rates were around 7% in June 2008. The Fed propped up the US economy by pumping money and dumping interest rates into the “system.” For a great real life story about the Fed and the real estate bubble of 2008, go see the new movie called “The Big Short” and the must see documentary, “Inside Job” (available on Netflix).
The result of the Fed and their “quantitative easing” (QE) created massive liquidity and debt.
Before the financial crisis, in 2007, we had less than $9 trillion outstanding in US national debt. Today our US national debt has more than doubled since the last recession and will hit $20 trillion in 2016.
If a recession takes hold, those greedy guru’s kowtowing to Wall Street won’t able to lower interest rates this time around, (e.g. interest rates won’t go negative). Thus, the weapons deployed to recover from the last financial crisis are not available this time around.
In fact, with the Fed raising interest rates, the probability of a recession increase dramatically. Ironically, simply the “discussion” about rising interest rates has as much effect on the economy as the actual reality of an increase in rates. This is called “jaw boning” and is one of the ways the FED controls the direction of interest rates.
“The anticipation of an event is often more impactful than the event itself.”
Let’s just focus on the impact of rising rates on the housing market. Let’s assume a 30-year adjustable rate mortgage with a current interest rate of 3.5%. The majority of mortgages issued in America over the past ten years have been ARM’s (acronym for Adjustable Rate Mortgage).
If interest rates were to simply return to where they were in 2008, the interest rate on those adjustable rate loans would double. Meaning that the amount of interest on your mortgage loan payment for your home would also double! This is a double whammy because if one could not afford their mortgage payment, when they tried to sell their home, buyers would also have to settle for market rate loans at say 7% in this example, and many a) wouldn’t qualify and b) would not believe the property would be “worth” paying so much for it.
For example; if a $300,000 home with the same amount of a mortgage at 4% today, one would pay around $12,000 in interest annually. But at 7% the interest due would be $21,000 annually. To break it down further, at 31/2% the monthly payment would be approximately $1,432 (not including insurance or taxes). But if interest rates on mortgages increased to 7%, the monthly payment on that same mortgage amount would increase to $1,996, plus insurance and taxes. And what if interest rates were to go as high as they did in 1982? Mortgages back then had an effective rate of over 18%! My first mortgage in 1984 was 14% and I felt that was a “good deal.”
It is not unrealistic to think mortgage rates could return to 7% or higher.
What has actually happened more than once in history, is that while the payments on an existing mortgage increase rapidly, the value of the home often decreases because the mortgage a buyer of your home would obtain will be much less than the market value before interest rates increased. Thus, if the “market” buyer could only afford a $1,432 monthly payment on our hypothetical $300,000 home, the purchase price of that home must drop to $215,240 to result in the required payment amount.
And we know that the average homeowner under age 65 has about 15% equity in their home. So in our example, (which is a conservative proposition), most homeowners would be underwater in their home mortgages when interest rates rise.
Beginning to look like the 2008 financial crisis all over again… and 1981 when the Savings & Loans Banks failed thereby bankrupting the Federal Savings & Loan Insurance Corp (FSLIC), which then created the Resolution Trust Corp (RTC) to bail out the banks; which was eerily similar to the Troubled Asset Relief Program (TARP) created in 2008 to bail out the “too big to fail” banks.
So, “The #Fed raised interest rates. What does this mean to you?”
It means that history repeats itself and local baby boomers, generation x and nearly everyone that has debt outstanding are in a precarious financial position today. Higher interest rates makes loans cost more, adding to the higher cost of everything from cars to major household appliances for consumers and heavy equipment and inventory for businesses…
Houston we have a problem
The psychology of interest rate increases affects the labor market too. Employers “feel” uncertain about future prospects and thus either hold the line or reduce their labor costs (i.e. salaries and wages). Thus, the great “squeeze.” Increasing housing cost, decreasing house values and declining income/wages. But don’t worry, be happy. My Money Track can help you plan and prepare for an uncertain financial future. Check us out for money-saving tips and secret financial life hacks. We will help you get your money straight, get your budget set and get your life back!
The Fed’s decisions affects anyone who has a home mortgage, a car loan, a savings account, or money invested in the stock market. In reality, that’s almost everyone in America. In fact, experts say, the impact is so far-reaching that even unemployed recent graduates living at home with their parents will feel it. So unless you live completely off the grid, it’s probably a good time to take notice. But then again, maybe it’ll be different this time?