By Marc S Schliefer, CFP®️RICP®️
Wealth Advisor and CEO
For the past 40 years, the inflation rate has been low and has not really been a big concern for most people. Mortgage rates have been below 5% for the past 12 years[1]. Over the last 4 years the rates were 4% or lower, while some people received rates in the low 2 percent range. Those days are probably gone for now. A rate of 5% is a shock – when only a year ago it was 2 to 3% — and is tough getting used to. We are now assuming that there will not be a lot of refinancing going on in the next few years. Most mortgages will be for purchases and for people that need to borrow money to buy a home or leverage their home equity to repair their homes.
If you flash back to 1981 when the average mortgage rate according to Freddie Mac data was 16.63%[2], the current 5% mortgaged rates seem not so bad. Today, people cannot imagine paying that type of high interest rate. However, the big difference is that you could buy a very nice home in 1981 for $200,000 and now the price is many more times that. The overall cost of home ownership is changing because of higher principal and interest costs due to higher interest rates.
In addition to the higher rates, at some point the fixed income and interest of CDs and money market funds will eventually rise. Now the interest rates are below 1%. Most are at .1 to .5%. As interest rates increase, the interest rates that you get from bank savings will increase again. In the year 2000[3] it was possible to get 5% CD rates; money market rates were not much lower than that. In fact, many retired people used to live off the interest rates paid from their money markets and CD’s. Over the last 20 years, it has been impossible to do that since the rates have been so low. Potentially, we may see that reality again. Currently, you would be lucky to get a 1% CD rate for one year and, with inflation over 8.5%, you would lose 7.5% by trying to be safe with your money. This is not a good strategy in this environment. If rates go up, and inflation is below the interest rate, that equation gets a little bit better. The third factor to deal with is the taxes on the interest paid. The goal is to at least try to keep up with inflation, if possible.
Above only CDs and money market accounts were discussed. Now, it’s bonds. There are several types of bonds and many of them have similar characteristics. There are corporate bonds, US Government Bonds, and state and county municipal bonds. There are other variations of bonds, but these are the main categories. In general, municipal bonds pay tax free interest and corporate bonds pay taxable interest. They are both rated by their financial stability. The more highly rated, the lower the interest that they pay. More risky rated bonds pay higher interest rates. This article is about inflation and interest rates, so the bond information will be limed to that. The bonds that were issued over the past 20 years had low interest rates. As bond interest rates go up with inflation, and with the Fed raising the discount rate, the value of older bonds with lower interest rates will drop in value if they are not held to maturity. The reason is based on the income that they generate. If you have a $100,000 bond paying 3%, that is generating $3000 per year. If the new bonds pay 4%, a $100,000 bond generates $4000 in interest per year. If you needed to sell your 3% bond in a 4% environment, you would get less than the face value depending on how much time is left on the bond. The moral of the story is that lower interest rate bonds tend to go down in value in rising interest rate markets.
These are some of the things that will be going on as inflation and higher interest rates become part of the new landscape. If you need any help navigating through your personal finances, please feel free to email me at marcs@equityplanning.com and I will be happy to answer your questions.
[1] Historical Mortgage Rates from The 1970s To 2021: Averages And Trends, KEVIN GRAHAM
[1] Historical Mortgage Rates from The 1970s To 2021: Averages And Trends, KEVIN GRAHAM
[1] Historical CD interest rates: 1984-2022, Libby Wells
