In the last few years you may have heard something in the news that has not happened for a while: The Federal Reserve is gently raising its target interest rate, the effective “federal funds rate.” The Fed held this rate at about zero from late 2007 until the end of 2015, but fearing an overheating economy, it’s taking action. It last began raising the rate in the mid-2000s to deter lending during the real-estate bubble. The funds rate is a device the government uses to manage the economy, specifically bank lending, so it can affect debtors, homeowners, and bankruptcy filings. But how?
To put it succinctly, the funds rate is the interest-rate floor at which banks lend to one another to cover their overnight reserve requirements. If the rate is low, then banks will lend to the public knowing that it won’t cost them much to maintain their reserves. When it’s high, then banks will curb their lending. The Fed indirectly (that’s why it’s an “effective” rate) targets a higher rate to slow down the economy to curb inflation, or it targets a lower rate to stimulate lending and hopefully employment.
How this translates to consumers is a different matter, but no one expects the Fed to raise its funds rate target particularly high in the near future. The effects will be muted, but they will tend to exist. Here are a few ways.
- Inflation. Most of the time, we think of how inflation affects consumers: higher prices for the same goods of the same quality. For debtors, though, it erodes the value of their debts. As the Fed raises the funds rate, the slight advantage inflation grants debtors diminishes.
- Jobs and building. As rates rise, job growth and new construction slows. Notably, there’s a knock-on effect, less construction means less housing, which implies higher rents for those who don’t buy homes soon. For debtors struggling to pay loans or find work at all, the Fed’s actions will not help.
- Credit-card debts. Lenders tie credit-card interest rates to the funds rate. That means debtors with high balances will pay more interest on existing and future balances.
- Auto loans. Loans for cars aren’t as closely tethered to the funds rate as credit cards, but the connection is still noticeable. Higher rates reduce car sales but can stimulate sales in cheaper used cars. Debtors are more likely to have fixed-rate auto loans, so the overall impact on their monthly payments is likely to be low.
- Mortgages. As with auto loans, the effect of the Fed’s rate increase on mortgage interest rates is negligible. However, because home prices tend to be large numbers, a slight change in interest rates can result in a bigger impact. An interest-rate shift from 2.5 percent to 2.7 percent will add more than $300 in mortgage payments annually. That means homeowners with adjustable rates will pay more to their lenders than before. Finally, as interest rates go up, asset prices, especially for houses, falls. That can mean reduced equity for homeowners as well.
For the most part, the Fed’s goal of raising rates will not help debtors or homeowners. It will make money tighter, adjustable payments higher, home prices lower, and jobs scarcer. It’s possible that small rate hikes that the Fed has in mind will increase bankruptcy filings, but it won’t be obvious. If your financial situation is worsening, then consulting with an experienced New York bankruptcy lawyer can help you assess your options.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.
