2014 Interest-Rate Outlook: Higher Rates for Borrowers, Little Change for Savers

Rising interest rates have been the talk of Wall Street—and Main Street—for months. Despite the recent fluctuation in yields, the return on ten-year Treasuries has climbed more than one-half percentage point over the past 12 months, to 2.7%, and Kiplinger’s expects yields to reach 3.5% by the end of 2014.

But not all rates are rising. The rates you earn on your savings accounts and on money market funds haven’t budged, and that’s not expected to change.

That’s because short-term rates are “anchored” by the Federal Reserve’s monetary policy, says Warren Pierson, a fixed-income strategist at Robert W. Baird, an asset-management firm in Milwaukee. The Fed controls the federal funds rate—the rate that certain banks charge each other for overnight loans—which in turn guides other short-term rates. That rate has been set at nearly zero since late 2008, and the Fed has said it will stick with its strategy until unemployment falls below 6.5%, which isn’t expected until 2015.

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Longer-term rates, however, are driven by the market—that is, bond buyers and sellers. Until recently, the Fed’s purchases of Treasuries and mortgage bonds have successfully held down long-term rates. As the economy improves and those purchases continue to shrink, long-term rates will rise. Here’s how the changing landscape will affect savers and borrowers.

Investors. Rising rates can do damage to your bond assets because when rates rise, bond prices fall. But it’s not wise to jettison bonds altogether (see 4 Bond Portfolios for More Income, Less Risk). So with short-term rates stuck and long-term rates on the rise, the best place to be is in intermediate-term corporate and government bond funds with maturities of six to seven years, says Jeff Moore, a fixed-income fund manager at Fidelity. If the threat of rising rates still keeps you up at night, stick with short-term investment-grade bond funds, such as Vanguard Short-Term Investment-Grade (symbol VFSTX).

Savers. Interest rates on money market accounts, savings accounts and shorter-term certificates of deposit will not climb much this year, if at all, says Greg McBride, of Bankrate.com. “Rates on three-year CDs and up could rise a quarter of a percentage point,” he says. Boost yields without locking in low rates by laddering CDs with maturities of one to five years, with average yields ranging from 0.22% to 0.79%. Credit unions can often do better: The rate on a five-year CD from PenFed with a $1,000 minimum deposit is 2.0%.

Borrowers. Mortgage rates—even initial rates on adjustable-rate loans—will grind higher in 2014, says McBride. Kiplinger’s expects the 30-year fixed-rate mortgage, recently just over 4.4%, to rise to 5% or 5.5% by year-end. That won’t halt the real estate recovery. A one percentage point rise from current rates means an extra $61 in monthly payments on a $100,000, 30-year loan. Still, consider locking in your rate once you have set your closing date. For credit cards and home-equity loans, 2014 could be the last hurrah for low rates, says McBride. Pay down your variable-rate debt before rates rise.