3 Ways Youll Be Affected When the Fed Raises Interest Rates

By Markets Fool.com

Exactly when the Federal Reserve finally decides to raise interest rates is anyone's guess. Every month, all eyes turn to the Fed to search for any clues in the language it uses to try and determine when a rate increase may come, and how much it might be.

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However, one thing is for sure -- the Fed will eventually raise rates, and when it does, your life is likely to be affected in several ways. Here are three examples of things that could change in your daily life once a rate increase finally happens.

Your credit card bills could get more expensive
The vast majority of credit cards in the United States have variable interest rates. Generally, your interest rate is determined by a set rate that comes from your particular cardholder agreement -- such as 17.9% -- added to the prime rate, which is derived from the Federal Funds Rate.

You may not notice too much of an impact, especially if you carry relatively low credit-card balances. However, if you have high credit-card debt, say $10,000, a small rate can be pretty noticeable. In this case, an extra 1% interest means an extra $100 per year. This would mean that, out of your monthly payment, about $8.00 more will go toward interest, not paying down your balance.

In short, a rate increase means it will either take you longer to pay off your credit cards by simply making the minimum payment, or your minimum payment amount may be increased.

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Some of your investments could be affected
Interest-rate changes can affect your investments in a variety of ways. For instance, banks with large lending portfolios can see profits rise with interest rates, because spreads between the interest banks pay and the interest they charge tend to widen as interest rates rise.

However, some investments can be negatively affected by rising interest rates. This is especially true with fixed-income investments like bonds.

Bond prices fluctuate based on the prevailing market interest rates and the "coupon rate" of the bond. For example, let's consider that you buy a 30-year Treasury bond today for $1,000 and that your bond has a coupon rate of 2.6%. The bond will pay out $26 per year for the next 30 years.

However, let's say that rates jump by 0.5%, and the standard coupon rate for 30-year Treasuries rises to 3.1%. Because that's the yield new investors expect, you would have to sell your bonds at a discount in order to make them competitive with the market. In order for your bond, which pays $26 per year, to yield 3.1%, its value would drop to about $840.

This is a simplified example, and there are a few other factors that contribute to bond prices. Plus, bonds with shorter maturities will be affected less than longer ones. Just be aware of how rising interest rates can affect your fixed-income investments.

Source: wikipedia user Jameslwoodward.

Are you planning to buy a house or car?
Interest rates on mortgage and auto loans are closely related to the Federal Funds Rate. While it's not exactly a perfect correlation, the rates tend to go up or down together.

What could this mean to you if you're planning to buy a home? If the Fed decides to raise rates by 0.5%, we'll assume that the mortgage rate you qualify for will jump from about 3.9%, where it is now, to 4.4%. On a $200,000, 30-year mortgage, this means the difference between monthly payments of $943 and $1,000. While this may not sound like much, that translates into $20,000 more throughout the life of the loan.

The effect on auto loans is less severe because of the shorter lengths of auto loans, but it will still get more expensive to finance a car, boat, or anything else for which you might need to borrow money.

The takeaway
These are three major things that will be affected when interest rates go up, but it's not an exhaustive list by any means. Rising interest rates will have a widespread impact on the economy, and will affect many aspects of your life, from how much you pay in certain retail stores to how much interest -- or lack thereof -- your savings account pays.

Rising interest rates are a when, not an if; but as long as you know what to expect, at least you won't be taken by surprise when your bond values fall, and it costs you more to borrow money.

The article 3 Ways Youll Be Affected When the Fed Raises Interest Rates originally appeared on Fool.com.

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