How rising interest rates will hit consumers

For the first time in over four years, the Federal Reserve is about to start raising interest rates - an action that it is likely to do repeatedly for the foreseeable future.

If the Fed does start to tighten the money spigot when it sets interest-rate policy Wednesday, it will mark the end of one of the longest period of low interest rates in recent times. And, as interest rates start to tick up - probably by only 1/4 of a point to start with - it will affect everyone from home buyers to the heavily indebted who carry significant balances on their credit cards.

The Fed's actions, however, will also indicate to the financial markets and the public that it is convinced that the US economy has turned the corner and can absorb the greater costs of money.

"The Fed's goal is to take its foot off the gas," says Richard DeKaser, chief economist at National City Corporation in Cleveland, Ohio. "It hasn't even begun to step on the brakes."

As the Fed raises interest rates, economists are trying to estimate the effect on the economy. In the past this was relatively easy to estimate. But now Americans have complex debt arrangements. For example, many people in refinancing their homes have consolidated their car and credit-card debt into their mortgages. "So, they are sheltered from the liability from interest-rate increases," says Mr. DeKaser.

Some of those who are not sheltered, however, include people taking out adjustable rate mortgages (ARMS) which may move up or down with short-term rates. Although many have interest-rate caps, including over the life of the loan, the rates can rise.

For example, Fannie Mae, the nation's largest source of financing for home mortgages, is projecting rising rates through the end of the year. It estimates that for someone who took out a $200,000 one-year ARM late last year, the mortgage payment could increase from $926 a month to $1,086, or about 17 percent by year-end.

The University of Michigan Surveys of Consumers, in fact, finds that people do expect the cost of borrowing to rise for the next several years, says Richard Curtin, the director of the Surveys. "That's a negative on the part of most consumers, but they expect that higher rates means more jobs," says Mr. Curtin in explaining why rising rates may not dampen spending immediately. "More people are expecting higher rates than ever before but that goes along with the fact rates are lower than ever before."

Those lower rates - and the prospect of higher ones - may be one reason why new-home sales are soaring.

Last week, the Commerce Department reported that new-home sales in May jumped 15 percent to a record level. "What I think we're seeing now is people who were fence sitting [are] jumping in, and that's accelerating the market," says David Seiders, chief economist for the National Association of Home Builders in Washington.

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