Rick Rodgers, CFP®, CRPC®
Certified Retirement Counselor®

The Federal Reserve raised interest rates in March. Their key short-term rate increased from 0.75% 1.0%.

It doesn’t sound like much, and you would hardly think it would even need to be reported. However, this is the highest their key short-term rate has been since 2008. Most analysts think the Fed will raise rates at least two more times this year.

Two weeks after the interest rate increase, the Fed released the minutes from this policy meeting, which revealed they may start selling some of the mortgage bonds they purchased over the last eight years.

The Fed’s easing strategy to stimulate economic growth relies on mortgage bonds

The Fed had purchased roughly $3 trillion of bonds as part of the quantitative easing strategy to stimulate economic growth by increasing the supply of money. Selling back these bonds will have the opposite effect and is expected to cause interest rates to increase. The financial markets have been anticipating rising rates but the latest developments may signal that rates will be going up faster than expected.

Rising interest rates do not impact the stock market directly, but the indirect effects are notable. Companies that regularly access the credit markets for funds will pay higher rates, which could reduce profits. Consumers may reduce purchase decisions on big-ticket items that require financing, which would reduce a company’s sales.

Banks in particular feel the effect as the cost of deposits increase. The amount of rate increases and how quickly they can deploy funds in the form of new loans at higher rates may squeeze earnings. Higher interest rates on income producing investments compete with stocks for the investor’s money. An investor may decide to allocate less of their portfolio to stocks if fixed income is yielding 4% instead of the current 2% rate.

The bond market is directly impacted by a rising interest rate environment. A bond with a fixed interest rate will decline in value when interest rates move higher. No one will buy an older bond with a 2% yield if they can get a new bond yielding 2 ½%. The older bond will have to be discounted in order to be competitive with new yields. The amount of the discount will depend on the time remaining until maturity because the bond will mature at face value.

Positioning your portfolio to succeed in a rising interest rate environment

This would be a good time to evaluate your portfolio to determine how you are positioned for a rising interest rate environment. It is also a good time to evaluate the debt side of your financial statement. Do you have loans with variable interest rates? Most home equity lines of credit (HELOC) are issued with variable rates.

This is also a good time to consider how long the balance may be outstanding on the HELOC. Locking in a fixed rate may be the prudent action to take before rates move higher.

Using home equity lines of credit (HELOC) when borrowing

Many people prefer to use HELOCs when borrowing because mortgage interest is generally tax-deductible. However, the rules for tax deductibility are not as flexible as many people think. Tax law allows the write-off of interest on up to $1 million of mortgages used to buy, build, or improve a primary residence and a second home, plus interest on up to $100,000 of home equity indebtedness. The key is whether the indebtedness is related to your home.

HELOCs are a popular way to consolidate high interest rate credit card debt, pay for college education, purchase a new car, or pay for a wedding or vacation trip. You can still deduct interest on a HELOC balance of up to $100,000. The problem for some people develops when the HELOC becomes a true revolving line of credit secured by the home. It is easy to exceed the $100,000 limit, after which interest paid on additional borrowed funds will no longer be tax-deductible.

How to lock in a long-term fixed rate using HELOCs

Refinancing your home and rolling the HELOC balance into a new mortgage is a way to lock in a long-term fixed rate. This option also has special rules to consider if you want to be able to deduct the interest.

  • The new mortgage is treated as home acquisition indebtedness only up to the amount of the balance of the old mortgage principal at the time of the refinancing.
  • If the refinanced loan balance increases by more than $100,000, the interest paid on the excess generally isn’t treated as mortgage interest.
  • The interest may still be deductible if you can show the loan proceeds were used for business or investment purposes. Otherwise, it’s nondeductible personal interest.

One last rule to remember is the maximum mortgage debt. The tax code permits deduction of the interest paid on up to $1 million in mortgage debt per couple, or $500,000 for a single filer. This can be on either a primary or secondary home, or the two combined. This amount is not impacted by refinancing, as long as the combined mortgage principal does not exceed the maximum. Click here to visit this article on Rick’s website.

Rick’s Tips:

  • The Federal Reserve has begun raising interest rates and further rate increases are anticipated.
  • Stocks prices are impacted by rate increases indirectly but bond prices are directly affected.
  • Mortgage interest is generally a tax-deductible expense but there are rules to follow.

By Rick Rodgers

Sponsored by Willow Valley Communities

Stay informed by reading, Don’t Retire Broke, by Rick Rodgers. It’s “an indispensable guide to tax-efficient retirement planning and financial freedom”. You can purchase Rick’s book here.

Tagged with:
 

Leave a Reply

Your email address will not be published. Required fields are marked *

*