By Andrea Coombes, CBS.MarketWatch.com
June 30, 2004

SAN FRANCISCO (CBS.MW) -- Many credit cards, home-equity credit lines and auto loans are about to get more expensive -- but only slightly.

The Federal Reserve's quarter-point hike in the federal funds rate -- to 1.25 percent from 1 percent, widely anticipated to be implemented Wednesday -- is in no way a signal for consumers to panic, though any credit they hold with a rate that's tied to the prime rate will move in tandem with the Fed's move.

Rather than worrying about Wednesday's action, now is the time to assess debts and investments with an eye toward the likely long-term outlook: Slow and steady rate hikes.

"The real news is the beginning of the tightening cycle," said Haseeb Ahmed, an economist with Economy.com. "It's just the start. It's just going to continue to go up from now."

Not that rate-hike expectations are a sure thing: One major terrorist event, for instance, could lead the Fed to drop rates again. But unless some seriously bad news emerges, the Fed's interest-rate moves will likely be a slow upward climb.

For the fed funds rate, "our forecast is 4.5 percent, but the Fed's not going to get there before 2006. It's going to be a gradual series of 25-basis-point moves at every Fed meeting henceforth, approximately. That's our baseline forecast," Ahmed said.

Adjusting to nervousness

Mortgage rates have already popped up in anticipation of today's hike, with rates averaging 6.25 percent last week, up almost a full percentage point from their lows in March. See How long can housing beat the rate-hike blues? Still, adjustable-rate mortgage borrowers with rates due to adjust in coming months may be experiencing sweaty palms. Some may be well served by refinancing before rates head much higher.

But interest rates aren't the only factor in the refinance decision, said Keith Gumbinger, vice president of HSH Associates, financial publishers and surveyors based in Pompton Plains, N.J.

"Should you refinance? Not necessarily," Gumbinger said. Homeowners should look at refinancing costs, and reassess their time horizon for staying in the house -- maybe a hybrid ARM with a slightly longer fixed-rate makes sense, maybe it doesn't.

Gumbinger said homeowners with ARMs should consider setting aside extra cash now, while rates are still low, to use as a buffer when rates, and thus their monthly payments, rise.

"Put it in a savings account and give yourself a pool of cash to use as a subsidy account when your interest rate ultimately does change," he said. Using extra cash to pay down principal is also good idea, but often less than inspiring. Putting an extra $100 toward, say, a $500,000 loan, "it takes a discouragingly long time to pay down your mortgage," Gumbinger said.

Others agreed that rising rates don't automatically signal the need for a change. "If your re-set is coming up in the next year, you probably ought to go ahead and refinance now," said Larry Goldstone, chief operating officer at Thornburg Mortgage, based in Santa Fe, New Mexico.

For someone with a 1-month ARM now, "getting a 30-year fixed is a bad decision," Goldstone said, because "the most dramatic increase that we're going to see is the Fed raising rates 300 basis points (or 3 percentage points) over the next couple of years."

Do ARMs still make sense for some borrowers, even as rates rise? "Absolutely," said Greg McBride, senior financial analyst at Bankrate.com. "The hybrid ARMs enable you to get a fixed rate that's lower than a traditional fixed-rate mortgage and if your time horizon proves correct, you'll never face that first rate adjustment."

Mortgage shoppers shouldn't forget the importance of rate locks in a rising-rate environment, said Bob Moulton, owner and founder of Americana Mortgage Group, based in Manhasset, N.Y.

Given the likelihood of continued rate hikes, "clients are looking into locking in their rates for an extended period of time," Moulton said, moving to 90-day locks from the standard 60 days.

Immediate effect on home-equity credit lines

Borrowers with home-equity credit lines may well see an immediate increase, albeit a small one.

The average rate nationwide on a variable-rate home-equity credit line is about 4.77 percent, according to Bankrate.com. "I expect the average to approach 5 percent within a few weeks," McBride said.

On an outstanding balance of $36,000, a quarter-point hike amounts to about $12 extra per month. "Nobody wants to send more money to their lender, that's true, but the good news is, it's not much," Gumbinger said.

Even if short-term interest rates were to rise three full percentage points, the prime rate (upon which most home equity lines and credit cards are based) would still be 7 percent, below the average prime rate for the last 10 years of 7.8 percent, Gumbinger said.

And some borrowers won't feel an initial hike at all, because their home-equity credit lines never fell below minimum rates that might be, say, 5 percent.

Credit card rates going up

Variable-rate credit-card holders will see an upward tick in their rates, while those with fixed-rate cards may soon be mailed a notice from their credit-card issuer informing them of rising rates since lenders can change fixed rates with 15 days' written notice.

But many people won't see a rate rise because they were never offered the benefits of lower interest to begin with. Lenders instituted rate floors when rates seemed to be in freefall, and those with, say, an 8 percent floor won't see a hike.

Still, anyone with credit-card debt should consider this rate hike a signal to do a financial check-up, said Jim Tehan, a spokesman with Myvesta.org, a nonprofit consumer education organization.

Almost 43 percent of Americans don't know their interest rates, according to a Myvesta survey. "You may be paying three different interest rates," Tehan said. Some lenders charge three different rates for purchases, balance transfers and cash advances, and some might be variable, some fixed.

"This is a really good time to take stock of your finances and make sure you are aware of what you're paying and of all the types of credit that you do have, and to get your finances under control," Tehan said.

Savers' savor rate hikes

For savers, benefits are already accruing in the form of rising rates on certificates of deposit and bank money-market accounts.

"CD rates have started to rise since the end of March," McBride said. "When Treasury yields began to move in expectation of rate hikes, fixed-mortgage rates and CD yields followed suit."

Still, don't start jumping for joy just yet. "It'll be a long road for CD yields to get back to historical norms," McBride said. "It took 13 (Fed rate cuts) to get them to record lows. It's going to take something pretty substantial for them to return to normal levels."

The average 5-year CD is yielding 3.6 percent, up from 2.89 percent at the end of March, while 1-year CD rates moved to 1.48 percent, up from 1.1 percent.

"There's not a lot of incentive to lock into long maturities now given the forecasts for higher rates," McBride said. "Keep your maturities at one year and less in order to give yourself the flexibility to reinvest at higher returns," he said.

However, those with a laddered portfolio shouldn't necessarily change their strategy at this point, he said.

Meanwhile, bank money-market accounts are offering about 2 percent interest. "Higher rates are good news to depositors, but inflation will still erode much of that return," McBride said. Inflation is running at about 2 percent annually.

Investors may be worried about interest-rate hikes, but their fears may be groundless. See full story on investing in a rising-rate environment.

Pedal to the auto-loan metal?

Do rising interest rates mean now is the time to jump into a low-rate auto loan? In a word: no. If interest rates were to go up a full percentage point, the monthly payment on a $25,000 loan with a five-year term would rise just $12, McBride said.

And rates are not going rise by a full percentage point overnight, though "it may happen by year-end," he said.

Rather than jumping into a new car loan ahead of an interest-rate rise, consider delaying until you have more cash to put toward a down payment, thus reducing the amount you need to finance, and increasing your equity in the car.

"I don't think you accelerate your purchase timetable based solely on the prospect of rising interest rates," McBride said. "You buy a car when it makes sense to buy a car."

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