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Why a Higher Interest Rate Doesn't Necessarily Mean You'll Pay More

by Jean Chatzky /
Whether the rate hike is good or bad depends on your financial situation. TODAY's Jean Chatzky explains.

The Fed raised interest rates on Wednesday for the second time in nearly a decade. This hike is a) small — only one-quarter of a percent — and b) totally anticipated. So how will it impact you? That depends on who you are:

Investor

Prepare for volatility — and lower returns — in the stock market.

Research by Robert Johnson, co-author of “Invest With The Fed,” shows that historically when rates were trending down, the S&P 500 returned an average of more than 15 percent annually. When they were trending up, the average return was 5.9 percent.

If you’re a younger investor, you can ride this out (focus on accumulating more shares at lower prices). If you’re in or very close to retirement, focus on stocks that pay dividends and make sure you don’t have so little in cash that you have to sell at a low point.

Related: Expect Three or More Rate Hikes in 2017, Says Yellen

As for bonds: Keep the quality high and focus on individual bonds (where you can hold them to maturity and not worry about fluctuating prices) rather than bond funds.

Saver

Eventually, rising rates will help the beleaguered savers who’ve seen anemic returns over the past half-decade or so. Always search for the best rates (on a site like Bankrate.com) that offer a substantial premium over the average ones.

If you’re buying certificates of deposit, or CDs, buy for short time periods so you can roll into higher interest rate CDS as they become available.

Homeowner

If you have an adjustable rate mortgage (ARM), don’t panic. If you rush to lock down your interest rate by refinancing into a fixed-rate loan, you’ll likely end up paying about a percentage point more. Hang in to see how far up rates are likely to go.

If you have a home equity line of credit, you’ll see an increase in your monthly payment in a billing cycle or two. Most HELOCs are tied to the prime rate, which moves in lockstep with the Fed fund rates.

Does that mean you should lock your rate down by converting to a fixed rate home equity loan? Nope. Stay where you are and work to pay the debt off. (This should be possible, as most outstanding HELOCs are in the tens of thousands of dollars, not hundreds of thousands.)

Home Buyer

The vast majority of the Fed’s expected rate hike is already baked into lending rates. They may go up a few basis points on Wednesday’s news, but any increase will be minor.

Home Seller

Rising rates typically put pressure on home sales, but don’t worry yet. The Fed will keep an eye on this — the last thing they want is to see is the finally resurgent housing market go in the tank.

Car Buyer

Car loan rates will go up with the increase in the Fed funds rate, but on a $25,000 car loan, we’re talking about a difference of a few dollars a month. Also, car financing deals below current rates — 0 or 0.09 percent, for instance, are often offered by manufacturers looking to move particular models. That won’t change, so keep looking for them.

Credit Card User

If you read your card agreement closely, you’ll notice that the interest you’re paying has a floor. For example, if your contract stipulates that you pay prime (currently 3.5 percent) plus 7 percent, with a floor of 12 percent, that means you should be paying 10.5 percent today but are actually paying 12 percent.

That explains why “it could be a while before many borrowers see much by way of effect,” according to HSH’s Gumbinger.

Related: One Year On, Are Chip Cards Effective — or Just Very Annoying?

Meantime, if you’ve got credit card debt you’re looking to pay off, a zero percent balance transfer offer is still going to be the way to go.

College Student

The rates on existing federal loans issued since 2010 won’t change. They’re set for life.

This year’s rates (3.76 percent for undergraduate direct loans) are set until July 1, 2017. At that point, they’ll be reset based on the May auction of 10-year Treasury notes. Officials add 2.05 percent to that number to determine the new rate for undergraduate direct loans, 3.6 percent for graduate direct loans, and 4.6 percent for PLUS Loans.

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