How to Prepare for Rising Interest Rates

Rising Interest Rates Key takeaways

• If it appears that interest rates could be rising soon, it might be a good time to refinance your house, especially if you have an adjustable-rate mortgage.
• A personal loan or a 0% balance transfer card could help you pay off high-interest, variable rate credit card debt.
• A CD ladder could help your bank deposits get a better return as rates increase.

In 2022, the Federal Reserve steadily increased interest rates in an attempt to tame high inflation. As of November, the Federal Reserve increased its benchmark interest rate 6 times. When interest rates rise, we can see the impact on many things, including mortgage rates, auto loans, credit card debt, and long-term and short-term bonds.

It’s important to understand how rate hikes can impact your personal finances. In this article, you’ll learn how to prepare for rising interest rates before the next rate increase takes effect.

How do rising interest rates combat inflation?

With higher rates, it becomes more expensive for consumers and businesses to borrow money. That slows down the economy, reducing the demand for goods and services. Ultimately, it lowers the inflation rate and puts a stop to soaring prices and market volatility.

Let’s say you’re looking to buy a home, and you get a mortgage with a fixed rate. As the Fed pushes up interest rates, it costs banks and credit unions more to borrow. They pass on the costs of those higher interest rates to consumers. A fixed rate could be a nice hedge in a rate environment that’s heating up. After the next hike, banks are likely to charge higher interest for that mortgage.

Higher rates could stop some people from buying a home at all. It might cause others to buy less expensive homes than they had planned. When this happens, many businesses lose revenue, including real estate firms, lenders, home builders, movers, furniture stores, appliance stores, and home improvement stores.

What are the stakes?

The good news: There’s no need to panic. Fortunately, our economy has always been cyclical, and rates that rise will eventually come back down. But as rates continue to rise, it’s a good time to evaluate your long-term goals and fine-tune your financial planning.

If you’re reviewing your financial plan to prepare for an upcoming rate hike, remember the stakes.

Let’s look at an example. If you have $5,000 in a savings account that gets the average yield of 0.16% APY, you earn $8 in interest in a year. If you decide to place that $5,000 in a high-yield savings account with an APY of 2.5%, you’ll earn about $126 in interest in a year. For both types of accounts, you must weigh minimum balance requirements, minimum deposits, monthly fees, and accessibility. The difference between $126 and $8 is significant. Even so, it could be difficult to counteract the effects of inflation through the placement of your deposits.

Both of those interest rates were overshadowed by the 8.2% inflation rate in September 2022. To maintain the spending power of your assets, you want to earn more in interest than the inflation rate. Variable interest rates on consumer debt tend to increase along with inflation. Rising interest rates on credit cards and adjustable-rate mortgages will also impact your cash flow. However, there are things you can do with your debt to mitigate the costs of inflation.

What can you do when interest rates are rising?

It makes sense to look for ways to minimize the impact of rising interest rates to avoid any potential financial crisis. Here, we’ll look at some ideas to help you prepare when the Fed is raising rates.

Mortgages

There are a few ideas to consider when it comes to your mortgage:

• Adjustable-rate mortgage (ARM). If you have an ARM and you’re not planning to sell for at least 5 years, you could refinance to lock in a fixed-rate mortgage before interest rates rise.
• Home equity loan or home equity line of credit. A home equity line of credit works more like a credit card, and often will have an adjustable rate. You can borrow and repay funds as needed, with the amount available being based on your equity. If you have a line of credit, consider taking out a home equity loan to repay your outstanding balance. These loans offer a fixed interest rate and monthly payment, which means you’ll have a predictable repayment schedule.
• Refinancing. A homeowner might have a mortgage with a higher interest rate than the current market but is waiting for rates to get even lower to refinance. However, if the climate shifts the other way, it could be smart to refinance before rates rise.

Auto loans

If you’re shopping for a new car or already have a loan, here are a couple of things to consider:

• If you’re looking to buy a new car, try to do it before higher interest rates hit. Buying that new car will only get more expensive as interest rates rise. Your monthly payment will increase, and the kind of car you’re able to afford could change.
• Shop around when you’re looking for your new loan to find the most competitive rate.
• If you have an auto loan with a lower rate, avoid making extra payments on your loan for the time being. Chances are, there are better places you can apply those extra funds like credit card debt.

Savings accounts

Savings accounts can be a good place to keep your money as interest rates rise. But consider these points before you park your funds in one place:

• Avoid locking up your money in a single certificate of deposit (CD). Instead, opt for a CD ladder. A CD offers a fixed interest rate for a specific period of time, but with a CD ladder you divide a sum of money into equal amounts. Then, you buy CDs with different maturity dates—this is done to decrease the impact of interest rate changes and reinvestment risks. A ladder could generate higher returns than investing in a single CD.
• Minimize the amount of cash that you keep in your checking and standard savings accounts. Instead, optimize money markets to earn higher returns from higher interest rates.
• Don’t let low-yield accounts or high inflation keep you from saving more money. It’s always a good decision to continue building up your emergency fund.

Credit card debt

As we have detailed, rising rates mean your existing debt can increase without advance notice. That’s true even on credit card accounts that have a so-called “fixed-rate.”

Understand what the current interest rates are on each of your accounts, then prioritize paying off those outstanding balances.

If you can, consider a personal loan or a 0-percent balance transfer card to pay off high-interest rate debt.

Stocks and bonds

It’s smart to diversify your portfolio. Consider investments in a variety of assets, including stocks and bonds. However, investing in individual stocks, and even bonds, is risky.

You could consider mutual funds that focus on particular sectors that seem promising if rates rise. But first you should research the conditions that might cause rates to rise and understand the funds’ investment practices. It’s also important to check on the fees a fund charges.

Invest in a bond ladder.Like CD ladders, bond ladders are a series of bonds that mature at regular intervals. As rates rise, the bond could be reinvested at the higher rate.

This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.