Last week, U.S. Federal Reserve Chair Janet Yellen told Congress that the Fed would likely begin increasing interest rates as the economy continues to grow.
But what does that mean for people in Northwest Montana?
The Beacon spoke with Patrick Barkey, the director of the University of Montana’s Bureau of Business and Economic Research, as well as Jim Kenyon, CEO of Whitefish Credit Union, and Ron Rosenberg, CEO of Valley Bank, to answer some questions about interest rates and how they apply to the lives of the people living here.
What are Interest Rates?
At their most basic, interest rates are what it costs a borrower to get a loan from a lender. So if the interest rate on a loan was 3 percent, that would mean the borrower pays $3 per every $100 borrowed.
It’s essentially an agreement saying the borrower will pay back the loan, Barkey said.
There are different types of interest rates. Nominal is the most basic, with a percentage added. Real interest rates are a tad more complex, because they take inflation into consideration, and inflation can affect a lender or borrower’s purchasing power. Effective interest rates take compounding values into account. Variable interest rates change with the market, thus so do the payments, as opposed to a fixed rate.
When the Fed increases interest rates, banks follow suit because their cost of doing business goes up as well.
“Basically, in a very simple sense, there’s a whole family of interest rates out there and the Federal Reserve controls one end of that and has huge influence,” Barkey said.
Why Should I Care?
Interest rates determine how much a loan could cost, but their movement also gives signals about the economy.
“Rising rates is a good thing,” Kenyon of Whitefish Credit Union said. “I think people take that as counter intuitive. But the Fed’s not going to raise rates until they’re comfortable that the economy is humming along.”
For the last seven years, the Fed has kept its target overnight lending rate near zero as a way to combat the effects of the Great Recession. The rate has only been raised twice, once in 2015 and again in 2016, leaving America with historic lows for interest rates.
But it would take some time for changes to reach Montana, Rosenberg of Valley Bank, said.
“You’ll find that both on the deposit side and on the loan side, until a trend has been firmly established, that there will be lag on any net effect on the consumer,” Rosenberg said.
An increase in interest rates would be passed along to the consumer, Kenyon said, but if the economy is performing the way it should, the consumer should also see an increase in their paycheck. And while many indicators say the economy is recovering, wage growth isn’t yet among them. According to the U.S. Department of Labor, employers across the country added 227,000 workers in January, but the average hourly pay for those workers only rose 0.1 percent.
Kenyon believes this is why the Fed won’t raise rates at its March meeting, but he does expect one or two rate hikes this year, albeit graduals ones.
“If that is the case in essence it means the economy is doing well and it can support the higher rates,” he said.
Why Should My Wallet Care?
Another sign of a healthy economy is the willingness of consumers to borrow money again, for anything from buying a new motorcycle for fun or getting a mortgage on a first home.
“When the Fed adjusts, it impacts market rates,” Barkey said. “That’s everything from car loans, auto loans, business loans, anyone who’s borrowing money.”
News of the Fed potentially increasing the base rate has caused an increase in lending activity, Kenyon said, because people are trying to take advantage of the historically low rates before they go up.
“December was our biggest month of the year from a loan-volume standpoint and the fourth quarter was the biggest quarter of the year,” Kenyon said. “We have people choosing variable rate products too. It’s not just everyone looking to lock in on that fixed rate.”
Low interest rates also tend to punish savers and reward borrowers, Barkey said, which means every person with a savings account or retirement plan will be helped by the increase in interest rates because their money will start generating more money with higher rates.
Should I Panic If I’m Not Ready to Borrow?
“It’s kind of like the stock market. When do you buy on the stock market?” Kenyon said. “There are so many variables. I’m more of a proponent of when the time is right, try to make your best deal and don’t try to time the market.”
While interest rates are historically low, there are tools to help borrowers get better rates down the road, Kenyon said.
The fact that rates are historically low is also another reason not to panic if it’s not the perfect time to borrow right now, Barkey said, because increased rates will just bring them back closer to normal.
“Yes, interest rates are going up and there’s going to be winners and losers involved in that,” Barkey said. “What are they going up to? They’re going to something that’s still pretty low, and in the grand scheme of things, something that’s a little closer to historical averages. Is that going to derail growth? Probably not.”
Rosenberg said his bank does not anticipate dramatic changes in the calendar year based on the current predictions, and said that people shouldn’t panic about the increases.
“So much of the consumer confidence is emotionally driven,” Rosenberg said. “Everything is somewhat relative. If rates are going up, normally you’re going to find that payrolls are going up. But emotionally, it does alarm people that rates are going to increase.”
Kenyon noted that financial institutions have been operating on the smallest margin in history for the past 10 years, and if rates increase, borrowers will see that reflected in their payments. Mortgage rates will likely increase, because home prices aren’t likely to come down anytime soon, he said.