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Six smart money strategies when interest rates rise
For months now, market watchers and financial prognosticators have been predicting a rise in the federal funds rate—the chief tool that the Federal Open Market Committee uses to influence interest rates and the economy—from the historic low of 0.25, where it’s been stuck since December 2008. The Fed’s workings may seem far removed from consumers’ day-to-day financial decisions, but when the rate shifts upward, you will feel it in your wallet.
No one knows for sure when the Fed will make its move. But Mark Zandi, chief economist of Moody’s Analytics, points out, “This interest rate is the best-telegraphed hike in history. If you’re not ready for it, you’re not listening.”
Here are six ways in which an interest rate hike could affect you, and how you can prepare for it.
For more smart financial strategies read, ”Get the best rates on your savings.“
Credit card users with high balances
Credit card rates have held steady at about 13 percent for fixed rates and slightly under 16 percent for variable APRs for much of the low-rate period. Because credit card interest rates are tied to the prime rate and most credit cards have variable annual percentage rates (APR), the interest charged on your balance will fluctuate when the prime rate changes.
If you’ve got a good credit score, you’re probably already paying a relatively low interest rate on your balance and can expect more of the same. However, notes Kathy Jones, fixed income strategist at the Schwab Center for Financial Research, the lower your credit score, the more you’re going to feel a rate rise. That’s because credit card companies hedge their bets by hiking the cost of the money they loan people with fewer resources to pay it back. “Your rate probably would go up and you would pay more going forward until you prove yourself a more worthy credit risk,” says Dan Werner, senior equity analyst for Morningstar.
So what should you do? Reduce your balance. One option is to transfer it to a credit card with a lower rate, but be sure to read the fine print: Many low- or zero-rate cards charge a transfer fee, and rates can skyrocket after the initial promotion period. If you have a home equity line of credit, consider tapping that. “It will almost certainly be at a lower interest rate, and I’d rather pay 4 percent than 14 percent,” says David Schneider, certified financial planner and founder of Schneider Wealth Strategies, an independent firm in New York City. To avoid putting your home at risk, do that only if you’re 100 percent confident about your ability to pay the loan back.
New home buyers or mortgage holders
If you locked into a fixed-rate mortgage with a low rate, there’s no incentive to change. But if you have an adjustable-rate or jumbo mortgage, consider refinancing into a fixed-rate mortgage.
To do this, examine the terms of your existing mortgage and calculate the damage if the rates rose two or three percent. If you plan to stay in your home longer than three or four years and haven’t already refinanced into a 15- or 30-year fixed-rate mortgage, do it now before the Fed moves.
Home equity borrowers
Home equity lines of credit (HELOCs) are directly affected by Fed decisions. If interest rates ultimately rise by a couple of percentage points, Schneider warns, "You could be looking at a 50 to 100 percent increase in your payment."
Before applying for or increasing a HELOC, do the math.
Student loan borrowers
Federal loan rates are set by Congress at a fixed rate every year, so college students who have already secured their loans won’t see any change. The cost of private loans, however, is likely to rise.
So it may be a good idea to refinance to extend the repayment period; although you’ll be writing checks longer, the amounts will be lower. You can also get a somewhat lower rate if you opt for automatic payment.
Because it can be tough to qualify for a student loan refi compared to other types of loans—and you can’t refinance federal loans—consider asking a parent or grandparent to take it over. Jones offers a hypothetical situation of a college graduate paying 7.5% on her student debt. “If she has someone who wants to put some extra cash to work and is secure in her ability to pay it back, they could refinance the loan at 4 percent. They can’t earn anything close to 7.5% in a safe investment, so it’s a win/win for both.”
Savers
Savers who socked away their money in Certificates of Deposit (CDs) or bank money market accounts will finally catch a break, says Schneider. "CD rates will go up. Money market account rates will increase. An increase is a win for savers.”
But it’s not a slam-dunk. Pointing out that the Federal Reserve has an inflation target of two percent, Zandi predicts, “We’ll be in the low single digits for the foreseeable future.”
Whether one bank offers better rates on a CD than another depends on whether it feels the need to attract more deposits. “Right now, most retail banks are pretty flush with deposits,” Werner explains, so it’s unlikely that you’d see a significant jump in rates. In any case, he adds, most people view their CD or money market account as their financial safety net. “If you have a rainy day fund in the bank, how likely are you to move it down the street for 50 basis points?”
Roll over your CDs but leave enough flexibility to take advantage of future rate hikes.
Investors
Despite an initial hiccup when rates increase—the result of the rising cost of doing business—the stock market has historically done well when rates go from low to normal because that signals a healthier economy. Higher rates will “definitely be a positive for bank stocks,” says Werner, because their profit margins will finally widen after years of being compressed.
Bonds are more complicated. True, most people assume that if interest rates rise, bond funds values will slump. But the returns on a passive fixed-income portfolio comes more from returns on interest payments from individual bonds, reinvested and compounded over time, than a change in price. “There’s a good chance that the income will start to go up as rates rise, which could offset any price decline,” says Jones. Consult your financial adviser about increasing your investment.
— Catherine Fredman
A version of this article previously appeared in the August 2015 Consumer Reports Money Adviser.
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