How do rising interest rates affect my loans?
A growing economy is good right?
In theory yes, but it could also mean interest rates are more likely to go up. After a long period of maintaining relatively low interest rates, the Federal Reserve has raised rates for the third time in 2018. Experts are speculating whether there will be another increase before the end of the year and how many more we'll see in 2019.
What do rising rates mean?
Rate increases often mean you end up paying more for your loans since you'll need to pay more in interest. Interest rate increases affect all types of loans that tend to be variable rate – including credit cards, student loans, and home equity lines of credit – and can add up to you paying a lot more over the lifetime of your loan.
Most credit cards have variable annual percentage rates, which means the interest rate can change depending on the prime rate (a benchmark rate used by banks to set interest rates of consumer loans). Let's say you have a balance of $15,000 on a credit card that has a 15.25 percent APR. Every time the Fed raises rates, the interest rate on your credit card will increase as well. A 0.25 percent increase is expected in December, which would increase that credit card's interest rate to 15.50 percent.
What this all means is that you'll be looking at higher monthly payments even if you haven't spent any more money on your credit card. And if you're already on a tight budget, these increases can make it harder to keep up with your monthly payments.
Should I consolidate debt if rates are rising?
If you have a number of variable-rate loans with large balances, it may be worth considering consolidation into a fixed-rate loan. Since the Fed has already raised rates three times and is indicating future increases, it's not likely your rates will go down in the near future.
Consolidation is simply taking a new loan to pay off several other loans. Some people do this to simplify their finances because you can reduce the number of loan payments down to one. But the main reason many people consolidate is to save money on interest.
Let's look at someone who has $39,000 spread across various credit cards. While the rates of each card range from 15.00 up to 17.03 percent1, the combined interest rate of all the credit cards is 15.99 percent. If this person were trying to pay everything off in five years, they would pay $948.20 a month and a total of $17,891.82 in interest alone over the five years with no interest rate changes. On the other hand, if this person consolidated their debt into a loan that only charged 5.49 percent, they could pay less every month ($744.77) and much less in interest ($5,685.92) over the same five years.
In an environment like we’re currently in, where rates are expected to rise, a fixed rate makes long-term planning and budgeting much easier and you'll be sheltered from future increases. Consolidating with a lower, fixed-rate loan can have a positive impact on your finances.
Why doesn't everyone use fixed-rate loans?
Fixed-rate loans tend to have higher interest rates, which is often why people end up in variable rate options.
If you already have a variable loan, it can cost money to move your loan balance to a fixed-rate option. Personal loans often charge origination fees and many home equity loans charge closing costs. Some loans may even charge an annual service fee for the duration of your loan.
What loan is right for me?
While fixed-rate loans often look pricier than variable-rate loans at the beginning, the long-term view can change quickly in a rising rate environment. Rate increases can do some major damage to your budget as monthly payments change, and if you find yourself falling behind on your increased payments, they can negatively impact your credit score too.
A fixed-rate loan, on the other hand, can reduces stress since payments are predictable and steady.
When considering a loan – whether it’s for a home improvement project or debt consolidation – it's important to consider where interest rates are expected to go, how long you are planning to take to pay off your loans, and what the total costs will be inclusive of any fees that are being charged.
Figure's Home Equity Line is a low, fixed-rate loan that you can apply for in as little as five minutes and get funding in just five days**. There is only a single origination fee, which ranges from 0 to 4.99 percent, depending on the state in which your property is located. If you’re considering a loan, you may want to consider us.
1The average APR on credit cards is 17.14 percent, as of Dec. 2018, per https://www.creditcards.com/credit-card-news/rate-report.php
**The Figure Home Equity Line is an open-end product where the full loan amount (minus the origination fee) will be 100% drawn at the time of origination. The initial amount funded at origination will be based on a fixed rate; however, this product contains an additional draw feature. As the borrower repays the balance on the line, the borrower may make additional draws during the draw period. If the borrower elects to make an additional draw, the interest rate for that draw will be set as of the date of the draw and will be based on an Index, which is the Prime Rate published in the Wall Street Journal for the calendar month preceding the date of the additional draw, plus a fixed margin. Accordingly, the fixed rate for any additional draw may be higher than the fixed rate for the initial draw.
