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Interest Rates On The Way Up

The waiting game for rising interest rates may come to an end soon. Economists definitely agree that the Federal Reserve will raise rates this summer.

At one point, many predicted no rise in rates until the end of 2004 or early 2005. These predictions were based in part on a statement from the Fed pledging to be "patient" about raising rates.

Then, on May 4, the Fed announced that it believes rates can be raised "at a pace that is likely to be measured." The change in tone reflected improvements seen in the economy - falling unemployment numbers and overall growth in several areas. This prompted rate watchers to project rate increases in August.

However, following a sizzling job report released Friday, economists now believe that the Fed could raise rates at its June 29 meeting.

Whenever rates rise, you can bet that they will not jump by much - most likely only a quarter of a point.

The general public tends to dread rising interest rates, but the move is actually a signal that the economy "is headed in the right direction," The Early Show financial adviser Ray Martin explains. More jobs are being created and several sectors of the economy are experiencing growth.

Growth inherently means more people are spending more money.

Rate increases are the government's way to slow consumer spending. With fewer people buying, prices won't rise as quickly. In other words, higher interest rates prevent inflation.

So what does this mean for the average consumer?

The first thing that comes to mind for most people is their mortgage. If you're looking for a mortgage, want to refinance, or have an adjustable-rate mortgage, the summer increase should not make you panic. Yes, your monthly payments will go up some, but don't blow the increase out of proportion.

Interest rates are at their lowest level since 1958. So, even with a quarter-point or even half-point raise, mortgage rates remain at some of the lowest levels we've seen in years. It's still a good time to buy.

It's interesting to note that even though the Fed has not officially changed the interest rate since last June, mortgage rates have increased. As a matter of fact, they have risen in the last seven consecutive weeks.

The 30-year fixed mortgage rate is now at 6.12percent. This time last year the rate stood at 5.65 percent.

Why this change? Basically, anticipation of the Fed increasing rates is causing lenders to go ahead and increase rates now.

"Consumers taking out a mortgage in the near future are likely to see higher mortgage rates as long as the lenders believe there is a growing possibility of higher future interest rates," Martin notes.

Clearly, mortgage rates are not solely dependent on the Fed's set interest rate.

In late February, Fed Chair Alan Greenspan told a group of credit unions that American homeowners have done themselves a disservice in recent years by clinging to fixed-rate mortgages when they could have saved lots of money with adjustable rate mortgages.

But now that rates are on the rise, does this advice hold true?

According to Martin, homeowners should not necessarily shy away from ARMS right now. If the fixed portion of your ARM is set to expire in a year, and you plan to move in the next two or three years, keep your current mortgage. Likewise, if you are just getting into an ARM, but know you won't spend too many years in your new home, adjustable rate is still a good deal for you. On the other hand, if you're going to be in your home for quite some time, lock in a fixed-rate mortgage as soon as possible.

Another bright spot - a rate hike is good news for investors who have cash in money markets and other investments that depend on interest income. Let's face it - recent months of earning 1 percent or less on your money has been terrible. But things are about to change.

Martin has four suggestions for investors and savers looking for a place to park their cash.

Earnings on all of the accounts below will only increase as interest rates rise.

  • Money Markets
  • CDs
  • Series I (as in the letter "i" for inflation) Savings Bonds
  • Treasury Inflation Protected Securities (TIPS)

    Everyone is familiar with money markets and CDs. The other two investments both have a fixed rate of return, and additionally have an "inflation indexed" rate of return that is tied to the rate of the Consumer Price Index, or CPI. With rising interest rates and the possibility of higher inflation, these two investments are more likely to provide the best returns in the bond category.

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