Get ready for interest rates to rise

May 24, 2014 

A ho-hum interest rate environment can lull borrowers into thinking that cheap money will be with us, well, nearly forever. And one might think that talking about rates isn’t relevant.

But savers, borrowers and market watchers are wise to prepare for changes in the wind, even if huge rate increases aren’t on near-term forecasts.

“I expect interest rates on federal education loans to continue to rise each year for the next several years, especially as the Federal Reserve Board stops manipulating interest rates,” said Mark Kantrowitz of Edvisors.com.

As of July 1, federal student loan rates will edge up. Rates overall will be up 0.80 percent compared with current rates.

Federal Stafford Loans for undergraduate students will be 4.66 percent — up from 3.86 percent. Federal Stafford loans for graduate students will be 6.21 percent — up from 5.41 percent.

Federal Grad PLUS and Federal Parent PLUS loans will be at 7.21 percent — up from 6.41 percent.

The higher rates add about $46 to $49 a year to borrowing costs for every $10,000 in student loans borrowed on a 10-year term. Total costs would increase by $460 to $492 over a 10-year repayment term of the loans, Kantrowitz said.

Last year, federal student loan rates were unusually low, with nowhere to go but up, Kantrowitz said.

But by next year, he predicts rates could be higher than 6.8 percent on the Stafford loan and higher than 7.9 percent on PLUS loans.

Kantrowitz said he predicted rates would start heading up when Congress switched the way student loan rates are handled. Now interest rates are fixed, but each year’s loans are at a new fixed rate.

Congress changed the interest rate formula in August, retroactive to July 1, 2013.

Greg McBride, chief financial analyst for Bankrate.com, said shoppers would be wise to pay down their credit card debt now to avoid higher interest rates in the future.

When overall rates climb higher, rates will jump on variable rate credit cards —and the minimum payment goes up, too.

“2014 may be your last hurrah for paying down that debt in an environment with the tailwind of lower interest rates rather than the headwind of rising rates,” McBride said.

McBride said he would not be surprised to see credit card rates climb in the next year or so.

“You better have a game plan for paying it back,” McBride said.

“The liftoff on short-term rates by the Fed is still close to a year away (give or take a few months),” according to a May report by Diane Swonk, chief economist for Mesirow Financial in Chicago.

“Liftoff” is new lingo for the first increase in the Fed’s short-term interest rates from the current level of zero.

Rates could be held low as well by tensions in Ukraine that already led to lower bond yields in the U.S. and Europe, she noted.

Even so, savers can spot slight improvements here and there.

In May, the new rate on Series EE savings bonds was set at a fixed rate of 0.5 percent for 20 years. But if someone held that bond for 20 years, the bond would double in value and the effective rate would be just over 3.5 percent compounded semi-annually.

Though that rate is low, savers are getting a far better rate than the 0.1 percent they got on Series EE bonds from November through the end of April. That was the lowest fixed rate ever set for Series EE bonds.

But the upside again for truly long-term savers who bought those 0.1 percent bonds in recent months is if you’d wait until 2033 or longer to cash that bond, you would see the bond double in value and get a much higher effective rate. The key is the bond must be held up to the original maturity of 20 years to get that yield.

New Series I savings bonds, if bought from May through October, will earn a composite rate of 1.94 percent for six months.

Series I bonds fluctuate based on inflation. The earnings rate for Series I bonds is a combination of a fixed rate that applies for the life of the bond and the semiannual inflation rate. The fixed rate on I Bonds issued from May 1 through Oct. 31 is 0.10 percent.

But that fixed rate is lower than what savers got in the past. The fixed rate was 0.2 percent on I Bonds issued from November through April 30. So over the long run, those would be slightly better bonds for savers to hold onto. The initial composite rate for I bonds issued then was 1.38 percent — including the fixed rate at 0.2 percent.

Rates for savings bonds are set each May 1 and Nov. 1. Savings bonds held less than five years are subject to a three-month interest penalty. Both series I and EE bonds can be redeemed after 12 months and have an interest-bearing life of 30 years.

WHAT’S THE GAME PLAN IF HIGHER RATES ARE ON THE HORIZON?

 • Some advisers say savers with certificates of deposit or bonds want to limit their CDs to relatively short maturities. “We are also advising clients to lock in rates now for mortgages and other indebtedness if they have the opportunity to do so,” said Robert Bilkie, president of Sigma Investment Counselors in Southfield.

 • Make certain to pay more than the minimum payment on low-cost credit card debt. That way you’d be carrying less debt when rates climb higher. Carrying less debt can help boost a credit score. Credit reporting agencies track how much you pay each month, too.

 • CD rates have a long way to go before savers will be happy. The average rate on a one-year CD was 0.24 percent in mid-May, according to Bankrate.com. Shopping for the best rate can mean finding a one-year CD around 1.07 percent. The average rate on a five-year CD was 0.80 percent and the highest rates for those who shop around were about 2.3 percent, according to Bankrate.com.

Source: Detroit Free Press research Susan Tompor is the personal finance columnist for the Detroit Free Press. She can be reached at stompor@freepress.com.

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