What rising interest rates mean for your credit, loans, savings and more

Editor’s note: This is an updated version of a story that was published on August 26, 2022.

In an ongoing effort to stamp out high inflation, the Federal Reserve on Wednesday raised the bank lending rate from 3% to 3.25%.

It is the fifth increase in six by the US central bank months and its third consecutive 75 basis point increase, which it will put upward pressure on other interest rates throughout the economy.

For consumers, the Fed’s move will reignite the question of where to park savings for the best return and how to lower borrowing costs.

“Credit card rates are the highest since 1995, mortgage rates are the highest since 2008, and auto loan rates are the highest since 2012. With more rate hikes to come, there will be more strain on the budgets of households with variable rate debt, such as home equity loans. lines of credit and credit cards,” said Greg McBride, chief financial analyst at Bankrate.com. “On a positive note, savers are seeing high-yield savings accounts and certificates of deposit at levels last seen in 2009.”

Here are some ways to position your money so you can benefit from rising rates and protect yourself from them.

When the overnight bank lending rate — also known as the fed funds rate — rises, banks tend to follow suit with the lending rates they offer to their customers.

So you will see an increase in your credit card rates within a few statements.

Today, the average credit card rate is 18.16%, up from 16.3% earlier this year, according to Bankrate.com.

Top tip: If you carry balances on your credit cards (which usually have variable interest rates), consider transferring to a zero-rate balance transfer card that locks in a zero rate for 12 to 21 months.

“That isolates you [future] rate hikes, and gives you a clear path to pay off debt for good,” McBride said. “Less debt and more savings will allow you to better weather rising interest rates, and is especially valuable if the economy turns sour.”

Find out what fees you will have to pay, if any (such as a balance transfer fee or annual fee) and what penalties there will be if you make a late payment or fail to pay during the zero rate period. time. The best strategy is to always pay off as much of your balance as possible, and to do so on time each month before the zero rate period ends. Otherwise, the remaining balance will be subject to a new interest rate, which may be higher than it was before, if rates continue to rise.

If you can’t transfer to a zero rate balance card, another option may be to get a relatively low fixed rate personal loan.

Mortgage rates have risen in the past year, rising more than three percentage points.

The 30-year fixed-rate mortgage averaged 6.02% for the week ending Sept. 15, 5.89% last week, according to Freddie Mac. It’s more than that double what it was in mid-September last year (2.86%), and significantly higher than where it started this year (3.22%).

And mortgage rates might rise even more.

So if you’re close to buying or refinancing a home, lock in the lowest fixed rate available as soon as possible.

That being said, “don’t jump into a big purchase that isn’t right for you just because interest rates can go up. up. Rushing into a big-ticket item like a house or car that isn’t in your budget is a recipe for trouble, regardless of what interest rates will do in the future,” said Texas-based certified financial planner Lacy Rogers.

If you’re already a homeowner with an adjustable-rate line of credit, and you’ve used a portion of it for a home improvement project, McBride recommends asking your lender if it’s possible to fix the rate on your balance, effectively building it up. fixed rate home loan. Say you have a $50,000 line of credit but only used $20,000 to renew it. You would require a flat rate to be applied to the $20,000.

If that’s not possible, consider paying off that balance by taking out a HELOC with another lender at a lower promotional rate, McBride suggested.

If you’ve stashed cash in savings accounts and certificates of deposit at big banks that pay little interest, don’t expect that to change just because the Fed is raising rates, McBride said.

That’s because the big banks are swimming in deposits and don’t have to worry about attracting new customers.

Thanks to lackluster rates from the big players, the average savings rate at banks is now just 0.13%, down from 0.06% in January, according to Bankrate.com’s weekly survey of institutions dated Sept. 14. The average rate on a one-year CD is now 0.77% as of September 19, up from 0.14% at the start of the year.

But online banks and credit unions want to attract more deposits to fuel their booming lending businesses, McBride said. As a result, they are offering much higher rates and these have been increasing as benchmark rates have risen.

So shop around. Some online savings accounts today pay over 2%. And top-yielding one-year CDs offer 2.50%. If you’re looking to make a switch, however, be sure to choose only federally insured online banks and credit unions.

Given today’s high inflation rates, Series I savings bonds can be attractive because they are designed to preserve the purchasing power of your money. They are currently paying 9.62%.

But that rate will only be in effect for six months and if you buy an I-Bond by the end of October, the rate is scheduled to adjust after that. If inflation falls, the rate on the I-Bond will also fall.

There are some limitations. You can only invest $10,000 a year. You can’t buy it in the first year. And if you withdraw money between two and five years, you will lose the previous three months’ interest.

“In other words, I-Bonds are not a substitute for your savings account,” McBride said.

However, they retain the purchasing power of your $10,000 unless you need to touch it for at least five years, which is nothing. They can also be of particular benefit to people who plan to retire in the next 5 to 10 years, as they will serve as a safe annuity investment that they can tap into if needed in the early years of retirement.

If inflation sticks despite higher interest rates, you might want to put some money into Treasury Inflation-Protected Securities (TIPS), said Yung-Yu Ma, chief investment strategist at BMO Wealth Management.

The confusing mix of factors playing out in markets today makes it difficult to say which sector, asset class or company will fare well in a rising rate environment, Ma said.

“It’s not just rising rates and inflation, there are geopolitical concerns … And we have a slowdown that may or may not lead to a recession … It’s a rare, even rare, mix of multiple factors,” he said.

For example, financial services companies may do well during rising rates, partly because they can make more money on loans. But if there is an economic slowdown, a bank’s overall loan volume may decline.

As for real estate, Ma said, “interest and mortgage rates are significantly higher … and this headwind may continue for a few more quarters or more.”

Meanwhile, he added, “markets have priced themselves down, but they are still a good hedge given the uncertainty in the energy markets.”

It remains bullish on value stocks, especially the small caps, which have outperformed this year. “We expect this outperformance to continue for many years.” he said

But in general, Ma suggests making sure your overall portfolio is diversified in stocks. The idea is to hedge your bets, as some of these areas will thrive, but not all.

That is, if you plan to invest on a specific stock, consider the company’s pricing power and how consistent demand is for its product. For example, tech companies typically don’t benefit from rate hikes. But because cloud and software service providers pass on subscription prices to clients, they can rise with inflation, said certified financial planner Doug Flynn, co-founder of Flynn Zito Capital Management.

To the extent that you already own bonds, your bond prices will fall in a rising rate environment. But if you are in the market to buy bonds this trend can be beneficial, especially if you buy short-term bonds, i.e. one to three years. Because that’s their prices have fallen more relative to long-term bonds, and their yields have risen more. Usually short-term and long-term bonds move together.

“There is a very good chance short-term bonds, which are highly displaced,” Flynn said. “There is a similar opportunity for tax-free municipal bonds for those in higher income tax brackets.”

Ma added that 2-year Treasuries, which are yielding nearly 4%, are “attractive here because we don’t expect the Fed to go much beyond that level with short-term interest rates.”

Muni prices are down significantly, yields are up and many states are in better financial shape than they were before the pandemic, Flynn noted.

Other assets that can do well are so-called floating rate instruments for companies that need to raise money, Flynn said. The floating rate is tied to a short-term benchmark rate, such as the fed funds rate, so it will rise whenever the Fed raises rates.

But if you’re not a bond expert, you might be better off investing in a fund that specializes in taking advantage of the rising rate environment through floating rate instruments and bond income strategies. Flynn recommends looking for a strategic income or flexible-income mutual fund or ETF that will hold a wide variety of bonds.

“I don’t see many of these options in 401(k)s,” he said. But you can always ask your 401(k) provider to opt into your employer’s plan.