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Interest Rates and the Debt Ceiling Debate
I was talking to some clients that own a small business the other day, and they asked where interest rates are now. It occurred to me that if you haven’t borrowed money in a while, which these clients haven’t, then interest rates may not be something you are watching closely. Interest rates have changed dramatically over the last 12 months, so here’s an update on some of the key interest rates that people watch closely and have implication for your finances.
I’ll start with the prime rate. The prime rate is the rate at which most banks will lend to their best business customers. The prime rate is generally 3% above the Fed Funds rate, meaning that this rate is the one they have the greatest ability to affect. That rate has been going up and just reached 7.75% and will at least reach 8% within the next month. I think it will go even higher than that, eventually topping out between 8.5% and 9% before the Fed is done.
What are some of the implications of the Prime Rate? Some businesses have their borrowing rates locked in for 5-year or longer, so they aren’t dramatically affected by the prime rate, but others have their debt floating. For those with floating rate debt that is tied to prime, their interest cost has more than doubled over the last year. Depending on how much debt a small business has, this could narrow profit margin and, in some cases, even eliminate it. If those same small businesses had tight cash flow when the Prime rate was 3.25%, imagine how tight it is at these levels. Here is likely shakeout from this dramatic increase in the Prime Rate. Some businesses will be pulling back on growth because they are trying to service their debt. Other businesses will be going out of business because they cannot afford the additional interest. Finally, businesses with very little or no debt will be picking up extra business and buying out some of these struggling businesses. This is part of the business cycle, and that cycle is dramatically impacted by what happens to the Prime Rate. Interest rates will go up and will eventually come back down.
The second rate I’ll highlight is the 30-year fixed mortgage rate. In order to understand this rate, we need to understand another rate to which it is often tethered. The30-year mortgage rates tend to track the 10-year treasury bond of the U.S. government. This is the rate at which our treasury department is borrowing money from the public over the next 10-years. As of today, that rate is 3.62%, which is a little higher than it has been in the last couple of weeks. If the 10-year rate goes, up, 30-year mortgage rates often follow suit. Why is that? It is because investors are buying these mortgages. Even though most mortgages may be originated locally through a broker or a bank, they are often eventually sold to investors. These investors are comparing the rate they can get on your mortgage with what they could get on a 10-year government bond. So if the 10-year rate goes up, investors are going to require a higher rate on your mortgage, because it is a riskier investment than buying a U.S. government bond. As of today, those 30-year fixed mortgage rates are in the neighborhood of 6.75%. That is much higher than it was. Local banks, like ours, can often offer additional mortgage programs with creative structures that sometimes are going to be lower than what is typically offered with a 30-year fixed mortgage, so it’s worth checking with someone like us when the time rolls around for you to buy your next house.
What are some of the implications of the 30-year mortgage rate? Mortgage rates matter for the housing market, because they have an effect on the number of people that can afford a house. Rates more than doubling has pushed some hopeful homeowners into the rental market for now because they can’t afford a mortgage payment and all the taxes, insurance and repairs that come with homeownership. In this environment, you are going to see more people renting. Another implication with rates as high as they are now compared to the days of 2.75% mortgages, many people are “stuck” in their current house. They will be less likely to move, because doing so in today’s environment would increase their payment dramatically. Not only will it cost more to purchase a similar house, but their mortgage payment alone could be 50% higher because of rising interest rates. This will lead to fewer people moving, which leads to fewer houses on the market, which could keep housing prices pretty firm, or at least not decreasing by much. It doesn’t look like we will see a repeat of 2008. Prices should stay fairly consistent or decrease very little. More expenses may see more decline in prices, but overall the housing market should hold up based on what we know today.
A final implication about 30-year mortgage rates is that they move often, sometimes even by the hour. So if you are comparing rates with multiple financial institutions, make sure you quote them in the same hour to be fair. Some days over the last couple of month, these rates have swung by as much as .50% in one day. So you will not only want to check those rates at the same time, but you will also want to ask your institution how to lock your rate, so you are not subject to it going up on you.
Speaking earlier of government bonds and debt, we have a debt ceiling debate in the works, and it could get messy before all is said and done. The nation’s current debt ceiling stands at $31 trillion. The U.S. Government has hit this limit, so now talks are beginning to consider raising the limit. Some in Congress think this should be done immediately, while others think that spending in the future needs to be reduced as a concession to raise the debt ceiling. My guess is that a deal will get done, but probably in the 11th hour. According to Brian Wesbury with First Trust, that deal may include spending caps in the future, or a special commission charged with the task of reducing government spending in the future. In 2013 and 2018 we saw two government shutdowns either because an agreement couldn’t be reached on the debt ceiling or an agreement couldn’t be reached on a budget. It is very possible that we see one again before a deal is made. Or there could be a selective shutdown that closes some agencies while keeping others open. Expect to see this debate heat up in the headlines more and more in the weeks ahead.
What are the implications of this debate for us? It could lead to more market uncertainty, and maybe even more interest rate volatility. I’ve been preaching preparation for a recession for months now. Even though a few economic numbers have surprised to the upside recently, I still think it is wise to prepare for an economic slowdown sometime this year.
I began the podcast by sharing that the topic for today was driven by a recent conversation with one of our small business clients. At Foundation Bank, we love helping small businesses. We love offering more than money, we want to offer ideas. If you want us to take a look at your small businesses’ debt schedule and give you some fresh ideas on how to rework it, we’d love for you to start your financial conversation with us today. If you’ve found this podcast helpful, we hope you’ll subscribe to it in your favorite podcast app and share it on social media. Until our next episode, God bless you.
-President Chad P. Wilson, CFP
Today’s episode of “Money Matters” was written and recorded by President Chad P. Wilson of McKenzie Banking Company / Foundation Bank on February 7, 2023. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. MBC/Foundation Bank is an Equal Housing Lender, Member FDIC.