Small Business Taxes & Management

Special Report


Higher Interest Rates Coming--How They'll Affect You

 

Small Business Taxes & ManagementTM--Copyright 2015, A/N Group, Inc.

 

 

Introduction

As of this writing (December 14) the Fed appears to be ready to raise interest rates for the first time in nine years. Should you be worried?

Before we discuss any of the effects, keep in mind that the Fed has been toying with an increase for some time now. They haven't made a move because the economy hasn't been exactly ebullient and inflation is minimal. If there is an increase in rates this week, it's likely to be nominal. And the next increase may not happen for some time. On the other hand, it could be an excuse for lenders to raise borrowing rates. There's a good chance that the impact of the first increase has already been factored into the mix.

 

Effects

Will the increase affect you? In some way it will affect everyone, but how much depends on your particular circumstances. If you've got a fixed rate mortgage, minimum credit card debt, and you're not invested in bonds, any effect may go unnoticed. But if you're investing in real estate, have heavy credit card debt, loans where your interest rate is pegged to the prime or another benchmark, you may want to consider the potential effects.

Bonds. Bonds and other fixed income securities are the first investments that come to mind when interest rates change. Prices on these instruments move inversely to interest rates. That means they'll drop in price as interest rates increase. How much? The biggest effect will be on the longest-term bonds, the least on shortest-term ones. Within a term, some bonds will do worse than others. Junk or bonds with a low credit rating generally take a harder hit than better rated ones.

Real Estate. These sector of the economy is affected because most real estate has some debt financing associated with it. If interest rates rise a typical borrower who can't afford a higher monthly payment will have to look for a less expensive property. That puts pressure on prices. While the same logic affects many other purchases, real estate is particularly sensitive because of the long term financing involved. How much of an effect? The table below assumes that a borrower can afford no more than $477.42 per month on a 30-year fixed mortgage. Here's how much of a mortgage he can afford at various interest rates:

	      4%         5%          6%          7%

           $100,000   $88,933     $79,628     $71,759

For example, you can just afford a $300,000 mortgage now, if interest rates move to 5%, you'd only be able to afford $266,799, $33,201 less ((100,000-88,939)x3). That's significant. If you're selling a property, it means you're likely to get less. Higher rates are likely to dampen price increases, but not by as much as the table would suggest because of other factors.

We're not suggesting rates will be going to 7%. Historically, rates have average closer to 6%. Note that the biggest drop in affordability is between 4% and 5%.

If you've got a fixed rate mortgage and you're not moving, there's no effect. Want to refinance? If you've got a mortgage at a higher rate, consider refinancing. Got an adjustable rate mortgage? Consider locking in a fixed rate.

Other Consumer Loans. Other consumer borrowing rates could increase. Credit card rates are susceptible to increases and auto loans are likely to increase. On auto loans, the biggest increase is likely to be on the longest term. Most vulnerable are those five years or longer. Leasing? Payments are likely to increase because there's an implied interest rate component.

Many lenders will probably use any rate increase to raise rates in order to boost profits.

Business Loans. Much the same applies to business loans. If you've got a fixed rate loan, there's no effect. But more than likely your loan is tied to the prime or another benchmark. On a positive note, some lenders who haven't been interested in smaller businesses may consider making loans at the higher rates.

Stocks and Other Investments. Some stocks are likely to perform relatively better than bonds under a rate increase. But some stocks are interest-rate sensitive. For example, the purchase of heavy machinery is usually financed with debt. That means the same rules apply here as to real estate. Less affordability puts pressure on prices and affects a company's earnings.

And some companies routinely finance operations with debt for one reason or another. That increases their expenses.

What's in Your Portfolio? Year-end is a good time to take stock of your investments--for investment and tax purposes. Bond holdings and mutual funds that invest in bonds deserve particular attention. Pay attention to any high-yield funds--both taxable and tax-exempt. Need a loss for tax purposes? You could sell now and invest in similar bonds down the road.

Hold more exotic investments? Some hedge funds and other investments can be particularly sensitive to interest rate movements.

Before making any moves, talk to your financial advisor.

Flip Side. What about savings rates? Don't look for much of a change here. Getting 5% again in your savings account just isn't going to happen anytime soon. Same for CDs. But now is not the time to go long term. Stay on the short side so you can roll over a CD to a higher rate when it expires. Same for bonds and other fixed income investments. Consider laddering your bonds and CDs.

 


Copyright 2015 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536


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--Last Update 12/14/15