The Federal Reserve may have been caught flat-footed while inflation made a historic run in the spring and summer of this year. In response, the central bank has enacted numerous rate hikes in an effort to cool the economy. The Fed has signaled it’s willing to push the economy into a recession if necessary. Despite two-quarters of negative GDP output some dither over the definition of a recession. Others are expressing concern about just how much contraction a supposedly healthy economy can bear as the federal government continues to accelerate its spending. However, what few are openly discussing are the real-life impacts the Federal Reserve’s policy shift will have on older Americans who are retired or on a fixed income.
In today’s rising interest rate environment one of the most vulnerable cohorts of older Americans are those
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carrying substantial credit card debt. Consider the following With the average credit card charging a 24% APR even a modest balance of $3,000 will require a monthly minimum payment of approximately $95 of which $65 or 68% is merely paying interest. It would take 16 years to pay off the total balance for a retiree-only making monthly minimum payments. During that time they would have incurred over $8,000 in interest charges!
Those wishing to reduce or eliminate interest charges on a credit card can seek a balance transfer to a zero-interest rate card during a promotional period, get a part-time job to pay down the balance, enroll in a non-profit debt management program that renovates a lower interest rate, or look to their home’s equity for relief.
The challenge in using home equity to pay down credit card debt is that banks are tightening their lending standards for home equity loans. This is not surprising considering that home sale prices and values are dropping as the economy slows. However, there’s one loan not subject a tightening credit market as banks seek to reduce their risk exposure- the federally-insured reverse mortgage or Home Equity Conversion Mortgage.
While many eligible HECM borrowers may have fewer loan proceeds to pay off an existing mortgage or credit card debt because of higher interest rates, others may not. As I mentioned on this show last week, many who were eligible but did not take the loan in 2019 or 2020 may in fact get more money than they would have two years ago, thanks to an average 42% increase in home values in 2020-21. Now, I’m going to pause for a moment here and remind our viewers I am not a financial advisor. I am a reverse mortgage commentator, trainer, and passionate supporter of the proper use of reverse mortgages. So always seek the advice of a trusted professional when considering a reverse mortgage.
All things considered, retirees are facing a perfect storm of stock market losses, higher interest rates, and a higher cost of living due to historic inflation rates. This will require a realistic consideration of their debt, monthly payment obligations, and the present value of their assets. Thankfully, one asset class has grown faster than the stock market. While the Dow Jones Industrial Average grew by over 25% in 2020 and 2021, many housing markets posted 30-40% price growth in the same period. Finding new sources of additional income from employment or utilizing existing assets are the likely choices retirees with modest savings will face in the coming years. However, while the typical price of home values and equities remain higher than they were before the pandemic, those values could retreat rapidly- a tragic lesson we’ve seen played out during the last great recession. Now more than ever before is the time to present possible solutions to our nation’s retirees.
Additional reading:
Labor Market Tightness during WWI and the Postwar Recession of 1920-1921
FED’S OWN ECONOMIST WARNS OF “SEVERE RECESSION” FROM CHAIR POWELL’S RATE HIKES
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1 Comment
Is recession going to roost and if so, when? If it does will it be a hard or soft landing? As to recessions is it better to be passive or proactive and if one does not respond in sufficient time to be proactive, is being reactive better than remaining passive? Are the economic gurus who react to almost all expansions to the economy as if Depression is coming forthwith and must be avoided at all costs, being overreactive? It is true that Depressions must be responded to as early as possible but can overreaction by itself produce irreversible damage to the economy unrelated to a Depression and can the proper time to respond to Depression be identified sufficiently in time to avoid another Great Depression? Do not misunderstand, there is no claim being made in this comment that the US is facing anything other than a recession.
Other than the long heralded and then discredited economic theories of John Keynes and the more recent supply-side economic theories of Arthur Laffer (and his Laffer curve), one is hard pressed to find economic theories from the ilk of these two well known economists to guide us out of the mess we are in. Certainly the European leaders are as lost, if not more lost, than we are.
While Jerome Powell may be blamed or credited for his recent actions, one big problem is that the current Administration and Cabinet of this President seemed as befuddled as the President and the Vice President about what to do. The President and Congress are busy creating historic spending bills that will increase the debt and exasperate the size and cost of interest at a time of rising interest rates. Other than the Fed, this federal group seems to be doing what it can to make the cost of interest squeeze the budget at the worst possible time. Imagine a conflict so great in Washington that the results seem more like a stalemate than a collaborative effort of all the responsible governing bodies in DC working together to end what could result in deep harm to the economy. (Yes, that was rank sarcasm).
Our country is not the Republic described by Richard Harris as the historical figure, Roman Emperor Marcus Aurelius in the film Gladiator, nor is it the idea of Elysium as evoked by Russell Crowe playing the fictitious commander of the Armies of the North and General of the Felix Legions, Maximus Decimus Meridius (although at times Maximus seems to be a composite of several actual Romans of the decades surrounding 170 AD).
Most of this potential recession is plain old American home made.
No one yet has come to the rescue of the seniors in this nation. To placate seniors, they are being told that Social Security Retirement Benefits will be almost 10% higher in 2023 but how do those promises help pay the increased costs endured in 2022? We, the RM originators, have a cash flow answer but not one that will avoid the real costs of increasing inflation. Our answer is a trade of interest (and MIP) bearing debt for the sunk costs of still raging inflation. Remember as of yet, inflation is stalled in a holding pattern but not corralled. Seniors need not only debt to meet their cash flow requirements but also genuine compensation paid to them for their losses due to the legacy ambitions of several of today’s politicians.