Interest rates have begun to rise, and they’re expected to continue going higher, but there are a variety of strategies you can employ to deal with them. And there’s still time to get your financial house in order before they go up even further, advisors say.
- The Federal Reserve has started raising its benchmark interest rate to rein in soaring inflation and plans a series of further hikes in the coming months.
- That means interest rates for all sorts of loans—including credit cards and home and auto loans—are set to go up as well.
- To counteract rising rates, consumers should consider paying down loans with high interest rates, locking in low rates when they can, and adopting some smart savings strategies.
Because the fed funds rate influences rates on everything from credit cards and home equity lines of credit to auto loans and fixed and adjustable-rate mortgages, consumers need to be prepared for this higher-rate environment.
“It’s good to take the opportunity to look at managing the debt you have before rates go up,” said Bruce McClary, senior vice president of communications at the National Foundation for Credit Counseling, a nonprofit financial counseling organization. “For those who say they are just getting by financially and are in a financially fragile state, the impact could be significant.”
And McClary estimated that a third of Americans are in the “financially fragile” category.
Following are five things all consumers should focus on, advisors said.
Credit Card Debt
Interest rates on credit cards are among the highest you’ll pay, and higher rates will only cost you more over the long run. So it makes financial sense to pay off the balance, or at least as much as you can, to minimize the total amount.
A lot of people “may have a financial hangover because they’re not getting government payments they once were and are now going on their credit cards,” said Craig Bolanos, CEO of Wealth Management Group. “That can get out of control quick.”
Bolanos said it doesn’t matter how you pay down your credit card debt—either by the “snowball” method of eliminating your smallest debt amounts first, or the “avalanche” method of first paying down debt that has the highest interest rates. Just try to get rid of it, he said.
If it’s not possible to eliminate all your credit card debt, another strategy is to consider refinancing or consolidating it. If you have a very good or exceptional FICO score (in the upper 700 to 800 range), taking one of those steps could give you a lower interest rate than you currently have, McClary said.
“This is especially important for people who have experienced an increase in their credit score during the time after they opened the account originally,” he said. “You can do that now, and the net savings on interest can be enough to create quite a nice buffer.”
But be sure to shop around and get the best deal, he added. “That’s the hardest part and takes time. You can’t do that quickly, so start now,” he said.
What’s more, the Fed’s benchmark interest rate influences mortgage rates, which had already been rising on their own without any help from the Fed.
It’s already too late to take advantage of the ultra-low mortgage rates that prevailed earlier in the pandemic era. With mortgage rates having risen to their highest levels since 2019 in recent weeks, home loans are getting less and less affordable by the day. For example, the average rate being offered for a 30-year fixed mortgage was 4.77% Thursday, far above the low point of 2.89% it hit in December 2020, according to data provided to The Balance.
And even small increases to mortgage interest rates can add significant amounts of money to the cost of buying a home. For example, the monthly payment for a home priced at the current median value of $350,300 for a 30-year fixed mortgage at 3% would run $1,182, but that would jump to $1,338 if the rate were bumped up just one percentage point to 4%. That means the pressure is on for anyone shopping for a home.
“It makes sense that if they're in a position to make a purchase to do it sooner,” Jaime Quiros, a financial planner for FBB Capital Partners, said.
Higher rates especially discourage refinancing, which usually makes sense only for homeowners who want to get a lower mortgage rate. Because of all the borrowing cost increases lately, only 13.1% of homeowners could knock at least half a percentage point off their interest rate through a refinance, mortgage giant Fannie Mae said in a report Thursday.
Indeed, refinancing has fallen 49% compared to a year ago, the Mortgage Bankers Association said this week.
For people who already own homes, a big risk from rising rates is if your home loan has an adjustable rate mortgage. When interest rates rise, so will the interest rate on your loan, meaning you’ll start paying more in interest with each monthly payment.
Individuals with federal student loans, which typically feature a relatively low fixed interest rate, shouldn’t be tempted to refinance them with a private lender, advisors say. Federal loans come with many benefits you will lose if you do that.
A major benefit of federal student loans includes affordable repayment options. For example, those who don’t earn a large-enough income may be able to opt during the loan for a so-called income-based repayment plan. It will set your monthly payments at an affordable amount, based on your annual discretionary income and family size.
Also, federal student loan repayments have been on hold since March 2020 and aren’t due to restart until after May 1, and it’s possible that deadline could be extended again. “There’s an outside chance with the way political winds are blowing, you could still get forgiveness,” Bolanos said.
Private loans, however, are completely different. If you have a low fixed rate on your private student loan, nothing changes no matter how many times the Fed may raise rates. If you have a variable rate, you should look to refinance and lock in a low rate now like you would for a home loan. If you’re having trouble making your payments, “work with an aggregator to consolidate your debt to get control right now,” Bolanos said.
If you’re considering making a major purchase like a home or car to take advantage of interest rates before they get higher, opinions vary on whether you should take the plunge now—or wait.
“Some people may need to buy now ahead of higher interest rates,” despite the fact that many things you’d buy on credit—such as cars—are super-expensive right now, said Conference Board Chief Economist Dana Peterson on a recent briefing call about inflation.
But McClary warned that if the purchase being pondered is non-essential, the prospect of rising rates is “no reason to start spending when you don’t have a need to do so.”
He emphasized that a series of interest rate increases over time won’t be a “seismic shift and derail budgets” right away.
“Even after the first rate hike, there’s time to adjust and plan strategically how to purchase things going forward and how it fits your budget,” he said. “It’s not a good idea to go into a panic-buying frenzy, instead of restructuring things you already owe. If you’re thinking of a major purchase that requires financing, like a house or car, think of that timeline and tightening it up. That’s more reasonable.”
As part of that, do the math yourself and consider what you’re buying. For example, if you’re aiming to buy a car for $30,000 and interest rates rise 1%, you’d likely only be paying a few extra hundred dollars on the car over five or six years, said Lee Baker, owner and president of Apex Financial Services. But what if the car is really worth closer to $25,000, absent inflation and the semiconductor shortage that pushed vehicle prices up last year? You may want to wait for the chip shortage to ease and prices to come back down again, he said, because the price differential would offset any 1% or 2% rise in the cost of financing.
But a house may be different, Baker added. With the current housing shortage, prices may not come down much, so, instead of waiting, it’s better to lock in a low rate now.
The upside of rising rates is that you’ll get a boost on the interest that’s earned on your savings, but you’ll still have to maximize your plans to get the most out of it. If you’re investing in a certificate of deposit, advisors recommend investing in short-term CDs to take advantage of every Fed rate hike in this cycle.
“Don’t renew into an 18-month CD,” Bolanos said. “Demand deposit rates will be yielding more by the end of the first quarter, so take short renewals, and start creating ‘CD ladders’ to ensure you’re capturing the highest rates—renewing into a higher rate.”
A “CD ladder” is a savings strategy where you invest a sum of money across a number of CDs with different maturity dates, meaning they’ll mature at different points in time. As each one matures, you can use the cash for another purpose or roll it over into new CDs.
In the end, McClary said, rising interest rates should pose a minimal problem for most consumers this year—but not for all of them.
“It’s not the end of the world, but if you have credit card debt and carry a balance month-to-month, it’ll likely cost you a little more,” he said. “Those who should be most concerned are those living on the edge, where every dollar is hard to come by and every dollar has to fit some place.”
The original version of this story was published on Feb. 4, 2021.