Interest rates are on the rise. If you are buying or selling a home or car, want to refinance a mortgage or take out a home-equity loan, have a pension, own stocks or bonds, or even just a bank deposit, then listen up.
For the last two generations, interest rates have generally declined. Back when Jimmy Carter was president in the late 1970s, a typical mortgage rate was as high as 18 percent. Today, despite recent increases, mortgage rates are still only 4.5 percent. To get a new-car loan back in the Carter years, an auto buyer had to pay a low double-digit rate. Today, a car loan can be had for less than half that.
Declining rates made homes more affordable and increased homeownership. They allowed homeowners to refinance mortgages and bring down their monthly payment even after taking equity out for home improvements, college educations, and new businesses.
Falling interest rates also pumped up stock prices and real estate values. Investors can purchase a Treasury bond with the certainty of getting the money back with interest. But when rates fall, investors collect less interest. That makes less-certain investments that promise, say, higher dividend payments in the case of stocks, or a rent payment in the case of real estate, more attractive. Falling rates made us collectively much wealthier.
But falling rates were then, and rising rates are now. It is increasingly clear that the era of rock-bottom interest rates is over. Not that we are going back to Carter-era rates, but if you have a 4 percent mortgage or a 5 percent car loan, count yourself lucky.
Driving interest rates higher are the massive deficit-financed tax cuts and government spending increases that the Trump administration and Congress agreed to a few months ago. The federal government has just begun to ramp up borrowing to pay for the lower corporate and personal tax rates and greater spending on the military and a panoply of non-defense programs.
This will juice the economy — temporarily. It will push down the nation’s unemployment rate, currently just over 4 percent, well into the 3s. This is rare territory. Unemployment has had a so-called 3-handle only three times in our history, and only briefly, because it has always resulted in accelerating inflation and higher interest rates.
On cue, the Federal Reserve has put everyone on notice that it plans, over the next several years, to steadily increase the short-term interest rates that it controls. If everything sticks to the Fed script, short rates — those for borrowing over a short time period — will nearly double between now and early in the next decade.
The Fed is also working to push up long-term interest rates — the cost of borrowing over a longer period, such as for a mortgage. Back when the economy was struggling, the Fed bought trillions of dollars in long-term bonds, successfully pushing down long rates. This policy was key to jump-starting the economy coming out of the Great Recession. Now with the economy going full-tilt, the Fed has stopped its bond buying. Less demand for bonds means higher rates.
Massive government borrowing to fund tax cuts and government spending are adding to the rate pressures. The federal budget deficit is on track to surge to more than $1 trillion next year, and according to the Congressional Budget Office, the nonpartisan agency that puts the numbers together, the red ink will only increase after that. The prospect of so much government borrowing is creating lots of agita for those investors being asked to buy all this debt.
President Trump’s recent threats of higher tariffs on our trading partners don’t help. Because our government borrows so much, we rely heavily on foreigners to buy a significant amount of our debt. China and Japan each own well more than $1 trillion in our Treasury bonds. They don’t need to sell our bonds for rates to rise; they only need to become less enthusiastic buyers. That’s not hard to envisage with the president railing against them.
To be sure, interest rates have been atypically low, and if they increase a bit because the economy is strong and unemployment low, then no big deal. The higher rates would just be symptomatic of a healthier economy. We will adjust.
However, adjusting to even modestly higher interest rates will be financially painful for many of us. It means buying a home or car will be less affordable, refinancing a mortgage uneconomical in most situations, higher credit card and home-equity payments, and softer stock values and house prices.
Most of us have never lived in a world of rising interest rates, at least not on any consistent basis. It will be a learning experience. Our education is just beginning.