Even as prospects for the US economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates.
That, economists say, is the inevitable outcome of the nation’s ballooning debt and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.
The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.
The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump. The rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31 last week, the highest level since last summer.
Along with the sell-off in bonds, the Federal Reserve has halted its emergency $1.25 trillion programme to buy mortgage debt, placing even more upward pressure on rates.
Each 1% increase in rates adds as much as 19% to the total cost of a home, according to Mayer.
The Mortgage Bankers Association expects the rise to continue, with the 30-year mortgage rate going to 5.5% by late summer and as high as 6% by the end of the year.
Another area in which higher rates are likely to affect consumers is credit card use. And last week, the Federal Reserve reported that the average interest rate on credit cards reached 14.26% in February, the highest since 2001. That is up from 12.03% when rates bottomed in the fourth quarter of 2008—a jump that amounts to about $200 a year in additional interest payments for the typical US household.
Similarly, many car loans have already become significantly more expensive, with rates at auto finance companies rising to 4.72% in February from 3.26% in December, according to the Federal Reserve.
Washington, too, is expecting to have to pay more to borrow the money it needs for programmes. The Office of Management and Budget expects the rate on the benchmark 10-year US treasury note to remain close to 3.9% for the rest of the year, but then rise to 4.5% in 2011 and 5% in 2012.
Last week, the yield on the benchmark 10-year treasury note briefly crossed the psychologically important threshold of 4%, as the treasury auctioned off $82 billion in new debt. That is nearly twice as much as the government paid in the fall of 2008, when investors sought out ultrasafe assets such as treasury securities after the collapse of Lehman Brothers and the beginning of the credit crisis.
Though still very low by historical standards, the rise of bond yields since then is reversing a decline that began in 1981, when 10-year note yields reached nearly 16%.
From that peak, steadily dropping interest rates have fed a three-decade lending boom, during which American consumers borrowed more and more, but managed to hold down the portion of their income devoted to paying off loans.
Indeed, total household debt is now nine times what it was in 1981—rising twice as fast as disposable income over the same period—yet the portion of disposable income that goes toward covering that debt has budged only slightly, increasing to 12.6% from 10.7%.
The long decline in rates also helped prop up the stock market; lower rates for investments like bonds make stocks more attractive.
That tailwind, which prevented even worse economic pain during the recession, has ceased, according to interviews with economists, analysts and money managers.
“We’ve had almost a 30-year rally,” said David Wyss, chief economist for Standard and Poor’s. “That’s come to an end.”
Just as significant as the bottom-line impact will be the psychological fallout from not being able to buy more while paying less—an unusual state of affairs that made consumer spending the most important measure of economic health.
For young home buyers today considering 30-year mortgages with a rate of just over 5%, it might be hard to conceive of a time like October 1981, when mortgage rates peaked at 18.2%. That meant monthly payments of $1,523 then compared with $556 now for a $100,000 loan.
No one expects rates to return to anything resembling 1981 levels. Still, for much of Wall Street, the question is not whether rates will go up, but rather by how much.
©2010/THE NEW YORK TIMES