Is it Possible to Change a 30-year Culture?

Even as prospects for the American economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates. The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.

Thirty Years – 1980. Think of these four cultural milestones that did not exist in 1980

1. Widespread credit card usage
2. Cell phones
3. Internet
4. Home Equity Lines of Credit

Since then, more than two generations of kids have grown up thinking that 0% financing for an automobile is only a good deal IF it comes with a rebate too. Two generations of kids – now adults - believing that refinancing your mortgage every few months to take the equity out to buy more stuff is smart financial planning. Two generations of kids – now adults – thinking that using credit cards to buy-now-pay-later is the American way.

The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump. The rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31 last week, the highest level since last summer.

“Mortgage rates are unlikely to go lower than they are now, and if they go higher, we’re likely to see a reversal of the gains in the housing market,” said Christopher J. Mayer, a professor of finance and economics at Columbia Business School. “It’s a really big risk.” Each increase of 1 percentage point in rates adds as much as 19 percent to the total cost of a home, according to Mr. Mayer.

The Mortgage Bankers Association expects the rise to continue, with the 30-year mortgage rate going to 5.5 percent by late summer and as high as 6 percent by the end of the year.

For young home buyers today considering 30-year mortgages with a rate of just over 5 percent, it might be hard to conceive of a time like October 1981, when mortgage rates peaked at 18.2 percent. That meant monthly payments of $1,523 then compared with $556 now for a $100,000 loan.

What a culture shift in 30 years.

Another area in which higher rates are likely to affect consumers is credit card use. And last week, the Federal Reserve reported that the average interest rate on credit cards reached 14.26 percent in February, the highest since 2001. That is up from 12.03 percent when rates bottomed in the fourth quarter of 2008 — a jump that amounts to about $200 a year in additional interest payments for the typical American household.

With losses from credit card defaults rising and with capital to back credit cards harder to come by, issuers are likely to increase rates to 16 or 17 percent by the fall, according to Dennis Moroney, a research director at the TowerGroup, a financial research company.

Similarly, many car loans have already become significantly more expensive, with rates at auto finance companies rising to 4.72 percent in February from 3.26 percent in December, according to the Federal Reserve. In 1980, car loan rates were in the 12-13% range and you had to have at least a 20% down payment to finance that car. And... the longest you could finance it was 48 months – no 60, 72 or 84 month financing.

It’s unlikely we will see rates back to the 1980 era – but any sustained period of “high” (you define it) interest rates will be very unsettling to those generations of kids – now adults – who have spent the past three decades enjoying some amazingly favorable interest rates.