My wife and I recently welcomed our 3rd son into this world, and with that addition found ourselves in need of a bigger vehicle. But during record high inflation and rising interest rates, the cost of borrowing money to finance more expensive purchases, such as a car, is a lot higher than it was just a year ago. I’m sure we’ve all heard that if you can, hold off on making some purchases until the economy is more stable. The philosophy is that if goods and services become too expensive, fewer people will buy them, and sellers will have to lower their prices to retain customers. For example, a car dealer may be forced to slash the price of a new car if potential buyers are unwilling to pay the extra interest rates for auto loans.1 But reality is not that simple. Numerous factors weigh into one’s decision when making larger purchases. Chip shortages, lack of supply, and increased demand have disrupted the auto market. Low inventory compared to demand continues to plague the housing market. And, as in our case, personal factors can dictate decision making as well. We opted to lease to avoid overpaying for a used car and will reassess our needs down the road. On the other hand, a client recently paid cash for a vehicle to avoid paying interest above what the bank was paying on their deposits.
The Fed continues to increase rates in 2023, with the February increase of 0.25 percentage points versus 0.50 in December. While the pace has slowed, Fed officials continue to signal there are more increases to come as inflation persists. For investors, this means rates for cash deposits have risen. For borrowers, this means even more interest on credit cards, student loans and other types of variable-rate debt. Mortgage rates on a 30-year fixed mortgage recently crossed the 7% mark when they have held below 5% since the financial crisis in 2008-2009. Auto loan rates are approaching or are over the 5% mark. How do the interest rate increases impact our decisions when it comes to these larger purchases?
If you are planning on making a large purchase in the near future, you should carefully consider your options before jumping in. Higher rates make it harder to qualify for a home loan as monthly payments increase and the income requirements do as well. Investments outside of retirement accounts could help increase a down payment to lower the monthly cost but may have tax consequences. Delaying the purchase may be appropriate if circumstances allow. Some buyers assume that if they lock in today at 7%, they’ll simply refinance when rates decline, but there’s no guarantee that mortgage rates will come down, or that home values will keep rising. Adjustable-rate mortgages offer a lower initial rate but carry significant risk.2 Fixed rate financing can offer some comfort in a predictable monthly payment. Talk to your advisor if you’re considering a large purchase to ensure a thoughtful approach in this new economic environment.
1 https://time.com/6251791/high-interest-rates-means-for-your-money/
2 https://www.washingtonpost.com/home/2022/10/04/house-buying-high-interest-rate/