Where will interest rates go from here? What the experts say
Interest rates have been getting lots of attention lately, and not just among economists and investment advisers.
Roughly three in four adults in a recent survey by Bankrate.com said they have financial regrets, and many involve interest rates — such as taking on too much credit card debt or buying more expensive homes than owners can afford.
Interest rates are intertwined in everyday life for most people, but they aren't always well understood. Here are answers to some common questions.
What exactly are interest rates?
You can think of interest as the cost, or price, to borrow money. When you take out a loan, you pay back the principal or amount borrowed, plus interest, often expressed as an annual percentage rate, or APR. Interest can be simple or compound. With compound interest, ongoing interest is tacked onto not just the principal (the amount borrowed) but also on any accrued interest, making the loan more expensive.
One prominent exception involves credit cards: If you pay off your balance each month, you wouldn’t incur interest, allowing for free short-term borrowing. Similarly, some banks and other lenders periodically offer short-term 0% financing deals for borrowers who transfer their balances from other credit cards. The banks offering such deals are betting you eventually will incur interest charges with them.
Where will interest rates go from here?
That’s a difficult question to answer. Many investment firms employ specialists focused solely on rates, and they still often can’t get their predictions right. Federal Reserve actions influence rates, but so do investor expectations for inflation and other factors.
Currently, the consensus seems to be that the Fed has either stopped raising rates or has only one or two more hikes coming. The most recent inflation news has been favorable, with the U.S. Consumer Price Index easing to 3% over the 12 months ending in June, down from a 2022 peak of 9.1%. Inflation got as high as 13.1% in metro Phoenix, driven by lofty housing costs here.
When inflation began to accelerate nearly two years ago, the Fed started hiking rates aggressively to cool things down. The approach seems to be working. Many economists worried that this braking action would slow the economy so much that it would roll over into a recession, but so far that hasn’t happened.
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Have rates started to drop?
It's more accurate to say interest rates appear to have stabilized rather than declined.
For example, average rates on 30-year mortgages have dipped to around 6.8% after hitting 7% in early July. Before that, rates on 30-year mortgages climbed from an average just near 3% in 2021 to 5.3% in 2022, reported Bankrate.com. In 1981, they touched 16.6%.
“Today, the current 30-year fixed rate is still relatively low in the historic scheme of things, though it may not feel that way, given its rapid ascent in 2022,” the company said in a commentary. Various online calculators, such as one at Bankrate.com, can help you assess your borrowing costs with mortgages at different rates and other variables.
Credit-card rates have pushed even higher, hitting an average 20.7% in May, reported the Federal Reserve Bank of St. Louis. That’s up from 14.6% in February 2022. These rates are much more sensitive to Fed decisions. Until the central bank starts cutting rates, many credit card users will continue facing hefty payments, even though inflation has cooled substantially in the interim.
Is there a relationship among different types of interest rates?
There are several. One involves the creditworthiness of the borrower. The federal government is considered the safest debtor around, so bonds issued by the U.S. Treasury typically carry the lowest rates, meaning the government can borrow more cheaply than everyone else. As another example, corporations are given credit ratings on the money they borrow such as when issuing bonds. Companies viewed as less stable pay more to borrow, while the strongest companies pay less.
Similarly, consumers are graded with credit scores that reflect their prior ability to pay bills and repay debt. Consumers with prime scores can borrow more cheaply, and have an easier time obtaining loans, than those with subprime grades.
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Another relationship that can affect rates reflects how soon the money must be paid back. Shorter-term loans are considered less risky than those maturing many years or even decades away — there’s simply less time for things to go wrong. That’s why, for example, short-term Treasury bills typically have lower yields, or pay lower rates, than longer-term Treasury notes or bonds.
Are high rates always a bad thing?
No. In addition to the beneficial impact they have had in containing inflation lately, today’s higher rates also have created better saving and investing opportunities.
For example, three-month bank certificates of deposit now pay nearly 5.2% on average, reports the Federal Reserve Bank of St. Louis. That’s up from 0.1% in October 2021. Similarly, you can buy corporate bonds or bond funds paying higher yields than was the case a year ago. And if rates start to fall meaningfully, existing bonds and bond funds become more valuable, creating the potential for capital gains. Similarly, declining-rate trends often ignite stock market rallies.
You also can make the case that higher rates discourage waste and speculation in business. As the St. Louis Fed noted, "Low interest rates encourage excess borrowing and higher debt levels.”
Conversely, higher rates encourage more financial discipline.
Are interest payments tax-deductible?
Some are and some aren’t. For consumers, mortgage rates generally are deductible, for both owner-occupied and rental homes. Over time, as homeowners gradually pay off their loans, with more of each payment going toward principal and less toward interest, homeowners will see this tax benefit diminish.
Other consumer interest payments aren’t tax-deductible, including those often-hefty payments on credit cards.
From the perspective of investors (as opposed to borrowers), bonds issued by state and local governments can be attractive because they often pay interest that avoids federal taxes (and sometimes state taxes, too). The higher the tax bracket in which you fall, the more attractive you will find these tax-exempt “municipal” bonds to be.
How do credit reports and scores tie into all of this?
Consumers with more consistent records of paying bills and repaying debts are viewed by lenders as more creditworthy, and that will give them access to credit-card offers, mortgages and other loans with lower interest rates.
Credit scores, in turn, are determined by payment information compiled in credit reports, which is why it’s a good idea to check your reports for accuracy from time to time. You can do so for free at annualcreditreport.com.
One prominent scoring system is the FICO scale from 300 to 850. As explained by Credit Karma, good scores fall between 670 and 739, very good are between 740 and 799 and excellent scores range from 800 on up.
Can interest rates work in my favor?
Yes, if you have money to lend or invest, rather than borrow. Long-term investors in the stock market, for example, can take advantage of compounding, as returns in a given year can build on those generated in the past. These investments don’t deliver positive results every year, but stocks historically have risen about three years in four, so compounding becomes a valuable tailwind.
For example, a $10,000 stake in a broadly diversified stock portfolio, earning a long-term compounded return of 9% annually, near the historic average, would be worth more than $106,000 after 20 years. It’s just that such results don’t come consistently but are subject to nerve-jarring bumps along the way. Nor are they guaranteed, of course.
One tool that can be helpful is called the “rule of 72.” This is a mathematical oddity that allows you to estimate how long it will take an investment to double in value if you know the expected interest rate or return.
As explained at Investor.gov, a website of the Securities and Exchange Commission, if you expect to earn around 9% annually, your investment should double in about eight years, as 72 divided by nine equals eight. At a 6% return, your investment would take around 12 years to double.
Reach the reporter at russ.wiles@arizonarepublic.com.
This article originally appeared on Arizona Republic: Where will interest rates go from here? What the experts say
