Are You Prepared For Higher Interest Rates?
We’ve been spoiled by years of bargain-basement interest rates since the financial crisis of 2009. But, even after the climb to a modest peak of 2%, the onset of the pandemic triggered the U.S. Federal Reserve (Fed) to maintain rates at or near zero. The primary reason was to stimulate an economy that came to a standstill.
However, with a sluggish, albeit welcome economic recovery, the Fed has taken the first steps in its promise to raise short-term interest rates. With several more increases projected for the remainder of the year to curtail inflation, these raises will affect consumers on many levels.
For starters, the cost of borrowing money for homes, cars, and other big-ticket items will increase. Already, new home sales have begun a cool-down as potential buyers realize the window for record low rates has started to close.
The clock is ticking as the Fed aggressively plans several rate hikes in the near future. As a result, now is the time to act to avoid paying more for that dream home, badly needed new car, and just some of life’s everyday necessities.
Start with checking your credit report
Before you start making any financial adjustments, it’s a good idea to confirm what’s in your credit report first. This ensures there are no errors in your information or balances, especially any inquiries for loans or cards you never applied for. Run a report with each of the three major bureaus, Equifax, Experian, and TransUnion, as your information can vary between records.
Shop around for mortgage rates
It’s always wise to check multiple lenders for the best mortgage rates. But now, this is even more crucial as consecutive rate increases loom. Even a slight rise in mortgage rates can substantially impact the cost of homeownership.
The following scenario demonstrates how much a monthly mortgage can change with a slight increase in the rate:
A prospective home buyer has his eye on a $300,000 property, and the bank offers a 3.5%, 30-year fixed interest rate. This translates to a total of $185,000 in interest added to their final cost. However, if this rate is increased to 4.5%, just 1% higher, the total interest would be $247,000 over the life of the loan. That means the homeowner must shell out almost $200 more a month.
If you are looking for a home, consider getting pre-approved for a mortgage. This will speed up the process towards closing, enabling you to lock in an affordable interest rate.
For homeowners that already have mortgages with variable rate financing, it would be wise to refinance them into a fixed rate. Once interest rates climb, those variable rates will also rise, substantially increasing monthly payments.
Reduce outstanding credit card debt
Higher APR and longer debt payoffs are the first noticeable side effects of an interest rate increase. Even small rate hikes will have a noticeable impact if you can only pay the minimum due on your credit card. This is because a higher amount of your monthly payment will be applied to the interest and less to the principal balance. However, time is on your side since credit card companies tend to respond gradually to rate increases.
To prepare for higher credit interest, establish a budget or modify an existing one to add to the monthly payments. Then, calculate how much additional money you need to compensate for an interest rate increase. Adding just a little more to your monthly payments can make a difference.
Another option is consolidating your outstanding balances and transferring them into a no-interest account. This action will prevent you from increasing rate hikes and make it easier for you to pay down the debt. Don’t sign up for the first offer you receive. Instead, weigh any fees and one-time interest charges between a few credit companies before going through with the balance transfer.
Work on improving your credit score
Your credit score can influence the interest rate a lender will offer you. Many financial institutions will save the best rates for the most reliable borrowers. As a result, those with the best credit histories and outstanding financial profiles will benefit the most. This is especially the case as interest rates begin to climb and many seek to consolidate their debts.
Make all of your monthly payments on time to improve your credit score. Additionally, your credit utilization ratio, which is the total of all your balances divided by the sum of your cards’ credit limits, should be no higher than 30 percent. For example, if you have $10,000 in outstanding bills, your combined balances should not exceed $3,000.
Be prepared for the possibility of a recession
History has shown us that a recession can result when the Fed aggressively raises interest rates. This occurred between 2015 and 2019 when the Fed’s actions resulted in a slowdown across all business sectors. They ultimately returned interest rates to pre-recession levels to stimulate the stagnated economy.
Another recession certainly can’t be ruled out in this volatile financial environment. While not nearly as severe as the effect of the pandemic, we may still see increased unemployment, reduced hiring, and market volatility.
The good news for savers
An increase in interest rates is not all bad news. Instead, they are a much-needed shot in the arm for consumers with savings accounts. Once rates increase, banks and credit unions will raise yields on savings accounts, CDs, and money market accounts that have remained near zero for the past several years.
The savings yields won’t skyrocket overnight but may result in increased competition among banks. As a result, it pays to compare rates and any incentives that several institutions offer.
Key takeaways
With the Fed’s plans to raise interest rates soon, now is the time to take a closer look at your financial picture. This will allow you to make some adjustments to withstand any economic instability.
Be proactive and develop a budget that will allow you to make additional payments on any debts you have. Additionally, focus on paying down high-interest debt and work towards improving your credit score. Finally, be prepared for the possibility of a recession by living within your means and saving as much as possible. By taking these steps now, you can weather any future rate hikes and keep your financial picture healthy.