After almost eight years, it seems like interest rates are going up again in 2016. To understand what might happen next year, let's look at why interest rates are so low today, why the Fed might raise them now, and what impact that could have on your finances.<\/p>\n
Lowering interest rates is one of the Federal Reserve's tools to stimulate the economy. Lower interest rates support business and consumer spending. They also make homes easier to finance, as we saw after the financial crisis.<\/p>\n
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For businesses, lower interest rates mean cheaper loans. This, in turn, gives companies an incentive to invest in innovation and new equipment to increase productivity in the future. In a high interest rate environment, it may be difficult to make a reasonable profit on investments.<\/p>\n
For consumers, low interest rates make saving less attractive, as interest rates on loan defaults, money market accounts and savings accounts generate little interest gains. Consumers tend to spend more money than save in such a case. This money could be invested in the stock market. It could be used to renovate the house or just to go to restaurants more often.<\/p>\n
In the housing market, low interest rates mean that the cost of buying a home will be reduced. At a 200.000 dollar mortgage with an interest rate of 7% and a 30 year term will have to pay 1 monthly.331 USD will be paid. If we lower the interest rate to 4%, then the monthly payment drops to $955. That's a 28% savings and a strong financial incentive for potential buyers.<\/p>\n
It's impossible to predict exactly where interest rates will be next year, but most experts expect any hike to be slow so as not to unnecessarily unsettle the markets or the economy. In the minutes of the Fed's October meeting, Chair Janet Yellen addressed the shift, saying, "A gradual increase into the target range for the federal funds rate is likely to be appropriate."<\/p>\n
But what exact numbers should experts expect to see? While it's just an estimate, Wells Fargo Economic Group expects a 30-year mortgage to rise to just 4.2% by the end of 2016. But they expect a bigger jump in short-term interest rates, with LIBOR expected to rise from around 0.35% to 1.45%. The prime rate is expected to rise from 3.25% to 4.25% and the Fed rate is expected to rise from 0.25% to 1.25%.<\/p>\n
Ending the stimulus of low interest rates seems like a bad idea when we consider how they drive the economy. But it doesn't necessarily have to come that way.<\/p>\n
First, too low interest rates over too long a period of time lead to high inflation. So far in this economic cycle, that hasn't happened, but it's a serious concern for the economy. High inflation is one of the most dangerous scenarios, as purchasing power decreases rapidly, effectively lowering living standards with each passing day.<\/p>\n
Second, cheap money can also tempt companies and individuals to take on too much debt, which can eventually lead to bubbles and economic collapse. Many experts point to the long period after the turn of the millennium. Low interest rates were one of the main reasons for the 2008-2009 financial crisis and housing market collapse at the time.<\/p>\n
Third, the Fed's decision indicates that the U.S. economy is now strong enough to grow without the additional stimulus. GDP growth has improved this year and employment is at its highest level since the recession.<\/p>\n
From this perspective, the decision is an indication that the U.S. economy is in good shape, even if it means that credit will now be more expensive.<\/p>\n
For investors, rising interest rates could be an opportunity to invest in a few interesting stocks. In a nutshell: I think it could be a good year for bank stocks.<\/p>\n
Banks will benefit from higher interest rates thanks to higher net interest margins. These measure the difference between what a bank pays in interest compared to what the bank earns in interest. A rise in interest rates helps banks raise rates on loans faster than they raise rates on savings accounts. This effectively increases your earnings without taking any other action.<\/p>\n
Based on quarterly reports and analyst estimates, the banks with the most earnings potential are Bank of America (WKN:858388) and the band with the most assets in America, JPMorgan Chase (WKN:850628).<\/p>\n
Let's take a look at Bank of America. In quarterly reports, the bank estimates that a 1% increase in interest rates should boost profits by $3.85 billion next year. During the 12 months from Q4 2014 to the end of Q3 2015, Bank of America reported net revenues of USD 16.3 billion. An increase of $3.85 billion would represent a 24% increase.<\/p>\n
Similarly, if interest rates rise 1% during the next year, JP Morgan Chase could boost profits by more than $2.7 billion. Based on total net income of $23.9 billion from the last 12 months, that would represent an 11.3% increase.<\/p>\n
Whether you're planning your 2016 spending, considering a mortgage or examining the impact of a rate hike on the stock market, 2016 will be busy. The Fed, the market and each of us has a front row seat to this one. We'll see up close how stocks, mortgage rates and the economy respond. Either way, it's going to be an interesting year.<\/p>\n
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Motley Fool owns and recommends Wells Fargo. The Motley Fool owns the following options: Short January 2016 $52 puts on Wells Fargo. The Motley Fool recommends Bank of America.<\/p>\n","protected":false},"excerpt":{"rendered":"
After almost eight years, it seems like interest rates are going up again in 2016. To understand what might happen<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[],"yoast_head":"\n