The Federal Reserve recently raised interest rates again with plans to raise them several more times this year, a move that has made it more expensive to borrow money. In response, Tim Billings, Bellco Credit Union Vice President of Treasury and Analytics, offered these helpful tips and a guide for navigating finances during turbulent times.
Tip #1: Understand Your Loan Structure: Fixed Rate or Variable Rate (Prime Rate)
Review your current loans (e.g., auto loan, mortgage, credit card balances, etc.) to determine if they are fixed rate or variable rate. It is critical to understand if the borrowed money is fixed at a certain rate determined at the outset of the loan, or, if the interest rate can vary based on changes in the market rates of interest, such as Prime Rate. “If you have a variable rate on these loans, your interest rate—and your payments—will most likely go up. Consider refinancing variable-rate loans at a fixed rate or transferring credit card balances to a fixed rate loan to avoid continued increases,” says Billings. It is key to note that if the interest rate on any loan is at a fixed rate, rising rates will not affect your loan or monthly obligation. If the interest rate on any loan is a rate that can vary based on a market rate such as the Prime Rate, rising interest rates will begin to increase the rate you pay on the borrowed money and therefore your total monthly loan payment amount.
Tip #2: Rising Interest Rates Will Affect Credit Card Accounts
The interest rate charged on credit card balances will vary with the market interest rates, so as rates rise, the interest rate on credit card balances will also increase. Interest rates charged on credit card accounts that maintain a balance over time tend to be some of the highest rates of interest. However, if you need to rely on that credit card for personal reasons, there are ways to mitigate the impact on rising interest rates and how much you are paying as a monthly payment.
A good technique to manage this is to look for other credit card offers that offer a “balance transfer” option for signing up with that card that offers a zero-percentage interest rate over a six- month, or one-year period. You can transfer a balance from a high-interest-rate credit card to the new zero-percent credit card to minimize the impact of rising interest rates.
However, Billings cautions people to read the fine print on any offer and to look for any high annual fees that may accompany a zero-percent balance transfer offer or any other fees that may be charged that may make that zero-percentage rate offer cost more than a current credit card.
Tip #3: Prepare a Solid and Realistic Household Budget
Slower economic growth tends to lead to higher unemployment rates, which will drive the Federal Reserve to either stop pushing interest rates higher or cause them to lower interest rates. This is the economic cycle. In general, people should look beyond the interest rate moves and spend time preparing a solid household budget designed to keep monthly expenses lower than monthly income. It is important to reserve a percentage of your monthly income (generally between 5% and 15%) to help save for the future or for an emergency situation. The most important thing is to not spend more than you are making and to prioritize putting some of your monthly income into savings.
Tip #4: Before You Make a Large Purchase, Do Your Homework
Before you make a large purchase that requires borrowing money, calculate what that loan would cost in terms of a monthly payment and incorporate that potential loan payment into your overall budget to ensure that the loan payment won’t stretch you too thin. Interest rates are higher right now, but they are still at levels that are among the lowest in 50 years.
“The most important aspect to a large purchase that requires a loan is to determine whether the person can afford the loan payment monthly, both now and in the future,” says Billings. “The best way to assess the affordability of a loan for a large purchase is to look at a loan that has a fixed rate of interest for the life of the loan. It is not advisable to try to ‘play’ the market in terms of making or not making a large purchase that requires a loan based on a view of where interest rates are now or where a person thinks they are going to be.”
Tip #5: Know When to Invest in an IRA, CD, or other Interest-Bearing Accounts
When you make the decision to put money into an interest-bearing account, the most important factor is the timeframe. “Will you need some of these savings in the near term for an emergency or do you have an emergency fund? Can you afford for these savings to be ‘locked up’ earning interest for a two-, three- or five-year timeframe for instance?” notes Billings.
“Let’s also make a distinction between a fixed rate CD account and a ‘savings’ account. Typically, a savings account can be any type of account where a household always has access to their money and can withdraw some amount of those savings without incurring any type of penalty or fee,” says Billings. “The interest rates on these types of savings accounts will generally go up or down depending on the general direction of market interest rates. So, in general, these types of savings accounts will tend to benefit with interest rates rising, as the person will typically see the interest they are paid on their savings increase as market rates increase.”
The second important factor of investing in fixed rate CD versus a variable rate money market account, is to understand your goals. If the goal is to grow over time at a the highest currently available interest rate, the current landscape of savings rates offered would favor investing in a CD rather than a money market account, because CDs are paying higher interest rates, Billings says.
It is not advisable to try to “time” the market in general in terms of where interest rates are now vs. where you think they are going. If a person has a strong feeling that interest rates will be higher next year than this year, invest in a one-year CD because you will be earning a higher rate of interest now. If interest rates are higher next year than this year, you can rollover that CD at a higher rate of interest then. If, on the other hand, a retired person is looking to invest savings in the safety of a financial institution as opposed to the stock market and the rate offered on a five-year CD right now gives that retired person the monthly income that they need in their budget, a longer-term five-year CD may make sens