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Some advice for borrowers, investors after rate hike: Take a deep breath

Fed raises key interest rate, foresees 3 hikes in 2017

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If you're about to buy a home, shop for a car or borrow for college, the pros have some advice:

Go ahead.

The Federal Reserve's decision Wednesday to slightly raise its key interest rate, advisers say, should have little immediate effect on mortgages or auto and student loans. The Fed doesn't directly affect those rates, at least not in the short run.

Nor should the economy's health be much affected by the Fed's move. Wednesday's rate hike, Fed Chair Janet Yellen said at a news conference, is a "vote of confidence in the economy."

That said, rates on some other loans -- notably credit cards, home equity loans and adjustable-rate mortgages -- will likely rise soon, though only modestly. Those rates are based on benchmarks like banks' prime rate, which moves in tandem with the Fed's key rate. After the Fed announced its rate increase, several banks said they were raising their prime rates to 3.75 percent from 3.5 percent.

In general, higher rates mean more expensive borrowing, explained Titus Pittman, financial adviser at Genesis Financial Partners in Jacksonville. 

"Well, for the average consumer, you should expect for those consumer loans like car purchases, things you put on your credit card or even purchases on mortgage -- the rate would slightly increase for each rate you pay on those particular loans," Pittman said. 

On the upside, Pittman pointed out that higher interest rates are good -- not great -- news for savers. 

"Those non-risky assets like savings accounts and money market accounts or CDs, we had very low rates. Now, this means that the rate will increase for those savers and you can look into going into more risk-free investments and yet get a greater return on those investments as we had not had in the last eight years," Pittman said. 

And if the Fed should accelerate its rate hikes, eventually rates on other categories of debt, like auto loans, would rise, too. On Wednesday, the Fed predicted it would raise rates three more times in 2017, up from two in its previous forecast.

But those predicted increases are just that -- predictions. A year ago, the Fed projected that it would raise rates four times in 2016 but has ended up doing so just once.

Mortgage rates had been surging before the Fed acted, for reasons that had little to do with the central bank. Rather, Donald Trump's election as president -- with his pledge to slash taxes, loosen regulations and increase infrastructure spending -- has raised the prospect of faster economic growth and inflation.

In response, the rate on the 10-year U.S. Treasury note has jumped about half a percentage point. Long-term mortgage rates tend to track the 10-year Treasury. The average rate on a 30-year fixed home loan is up nearly in lockstep with the 10-year Treasury -- to about 4.1 percent from 3.5 percent.

"The Fed isn't what's influencing mortgage rates right now," said Greg McBride, chief financial analyst at Bankrate.com.

Nela Richardson, chief economist at real estate brokerage Redfin, said:

"Mortgage rates will increase but not too much. As long as the Fed remains a trillion-dollar investor in the U.S. mortgage system, a moderate pickup in short-term rates won't dampen the strong home buying demand we've seen as a result of a strengthening economy."

Since Trump's election, investors have sent stock prices up and demanded higher bond yields. Faster economic growth tends to benefit stocks. And higher inflation erodes the value of bonds; their yields then rise until buyers return.

Yet it's unclear if investors' expectations will pan out. The markets appear to expect Trump to get Congress to enact steep tax cuts, a huge spending package to upgrade roads, bridges and airports and a softening of regulations in banking, energy and other sectors.

At least some of Trump's proposals could face resistance in Congress. They might not pass -- or at least not for months or even years.

"Markets seem to be pricing in this Goldilocks scenario where everything in Washington comes together for a tax cut and stimulus," says Scott Anderson, chief economist at Bank of the West. "That's a little Pollyanna-ish."

If Trump's program stalls and investors foresee less inflation and growth, the 10-year yield - and mortgage rates - could end up declining. Other factors could complicate the picture: The dollar has surged on expectations of higher growth and interest rates. A higher dollar makes U.S. goods costlier for foreigners and could slow the economy.

A stronger dollar could also cause pain in emerging markets, where companies have borrowed in dollars and could struggle to repay those loans. Tremors in the global economy could spill into the United States and slow growth and inflation. That would likely lead to lower rates.

That's a point for Americans to keep in mind as they consider taking out a home or auto loan. Mortgage rates and other borrowing costs won't likely rise in a straight line, which is why most people need not rush to lock in a rate.

"If you're a first-time homebuyer, yes, rates are higher than they were in September, but they're still reasonably attractive," says David Geibel of Girard Partners, a wealth management firm in King of Prussia, Pennsylvania. "You can still get a very juicy mortgage."

Tom Libby, an auto analyst for IHS Markit, noted that if the Fed raised rates three more times next year, auto loan rates would eventually rise and likely slow down auto sales. As much as 70 to 80 percent of new-car transactions are financed or leased and dependent on interest rates.

The zero-percent financing deals that have facilitated many auto sales could go away if the Fed keeps raising rates, Libby said.

And with some other categories of loans, like credit card or variable-rate debt, many advisers are recommending that clients lighten their loads. Variable-rate loans would begin to charge more interest.

"If their credit score is high enough that they can go out and get an installment loan right now and pay those credit cards off, they should do that," said Joe Heider of Cirrus Wealth Management in Cleveland. "If they have the ability to use a home equity line, they should be doing that as well to pay down those credit cards."

Rising rates can erode the value of investors' longer-term bonds. So they may not want to own many bonds that mature more than 10 years out, whether they're individual bonds or mutual funds that hold long-term bonds.

"Longer-term bonds are going to most likely be the biggest losers if the Fed embarks on a cycle of raising interest rates," said Ken Moraif of Money Matters, a wealth management firm in Dallas. "Shortening up the duration of the bonds in your portfolio is a very good idea."

Moraif has his clients now in bonds that mature in five to seven years.

Don't go too short, though. Though you'll lower your risk, you'll also unduly limit your potential returns. Intermediate-term bonds may be best for some.

Over time, if the Fed steadily raises short-term rates, savings accounts and certificates of deposit would finally begin to sport more attractive yields. Just don't expect that to happen soon.

"We're going to have to go through a series of rate hikes before savings accounts and short-term CDs are attractive again," Heider said.


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