Rising to the Challenge of Rising Rates
Earlier this week, the Federal Reserve raised interest rates for the third time this year, with another hike expected before 2019. As interest rates continue to rise, financial institutions and consumers alike will begin to feel the effects of this policy change.
The Fed has kept interest rates historically low since the 2008 financial crisis in order to assist with the economic recovery, but it has slowly begun increasing the federal funds rate. The federal funds rate is the rate at which banks can borrow from each other for short-term loans, and it helps determine the interest rates that consumers pay on loans, credit card debt, mortgages, and more. As the Fed hikes the federal funds rate, the interest rate that you pay on debt will also increase.
Though it makes debt more expensive for consumers, it’s actually a good sign that the Fed is raising interest rates: it shows that the Fed has confidence in the economy. However, the interest rate hikes could have a very real impact on your finances. You’re likely to see some changes in your investment portfolio, especially with regard to any bonds or bond funds that you hold, as they are particularly sensitive to interest rate changes. It’s unlikely, however, that your stock holdings will experience any significant changes as a result of the interest rate hikes, as the rate changes will not come as a surprise and should already be priced into the assets that you own.
Outside your investment portfolio, you are likely to see the changing interest rates reflected in your bank and loan accounts, but these changes won’t necessarily have a negative effect on your personal finances. Here are a few actions to consider to help you minimize the impact of rising rates and even take advantage of the increases:
Lock in the current low rates on long-term debt
If you’ve been considering refinancing your mortgage, this is a good time to see if you can secure a lower rate. As the Fed raises interest rates, mortgage rates are only going to increase, so you are very unlikely to receive a lower rate by waiting.
Make large purchases sooner rather than later
If you need a new house, a new car, or any other large item that would require a loan, you should consider making these purchases before future rate increases. Even though mortgage rates are already climbing with the interest rate hikes, the current rates are still low by historical standards, so locking in a mortgage or other long-term loan soon would still allow you to take advantage of the low rate environment.
Trade variable-rate loans for fixed-rate loans
Overall, variable-rate loans will become more expensive as interest rates rise, as their rates are designed to vary with the prevailing market interest rates. Generally speaking, variable-rate loans are a smart choice when interest rates are falling, because your interest rate will fall with the market rate. However, it’s typically cheaper to hold a fixed-rate loan when interest rates are rising or you may end up paying more than you expected for your debt.
Variable rates are common with certain types of long-term debt. If you have a variable-rate or adjustable-rate mortgage, especially one that is past the teaser period, you should review the terms of the mortgage to determine if you should lock in a fixed rate instead. Some student loan rates may also change as interest rates rise. Those who only have federal student debt won’t see any changes to the rates that they pay, but some who took out private loans may have variable-rate loans. Those variable-rate loans may become more expensive as interest rates rise unless you switch to a fixed rate.
Pay down any small outstanding debt
If you have any short-term debt, especially credit card debt, you should prioritize paying it down now. This is always a good practice, but it is especially important in a rising interest rate environment: the rates on your credit cards will almost certainly go up and you’ll end up paying more for existing debt. Paying off credit card debt now to the extent that you’re able will save you money in the long run. You should also keep an eye on the APR on your credit cards if you aren’t able to pay the full balance due each month, as those rates will increase with time.
Increase your savings rate (and maybe find a new bank)
The increased federal funds rate should eventually raise the rates on interest-bearing checking accounts and savings accounts at your bank, though it may take some time for those rate increases to actually trickle down to your accounts. These rate increases will be very small but they will make putting money in savings or checking accounts slightly more attractive, so it could be a good time to increase the amount of money that you’re saving. If your bank is slow to increase the interest rate on your account, you may want to consider shopping for a better rate. Many of the online-only banks have already raised interest rates on savings accounts, while the larger banks have been slower to pass the rates to their customers.
While significant changes are coming to the economy, rising interest rates shouldn’t cause anyone to panic. Some careful planning and a judicious treatment of debt should be enough to minimize the impact of rising interest rates on your personal finances.