Raising interest rates as a measure to combat inflation has been a hot topic lately. Not only did the Fed increase rates by 0.5% at its May FOMC meeting, but increased them again by a whopping 0.75% at the June meeting to make the highest rate increase we have seen since 1994.
But how does a rising rate environment affect your finances? This is truly the chief concern of most investors today, especially if rates continue to rise.
Here are some things to expect in a rising rate environment and ways to protect yourself:
- Variable loan costs rise: If you have a variable prime rate loan (e.g., mortgages, personal loans, or car loans), you may see your monthly payments increase when interest rates rise. If paying off these loans as quickly as possible is not an option, then converting the variable loan to a fixed loan would be the next best thing. Or you can choose to refinance before rates move too much higher.
- Bond markets fall: When interest rates rise, bond markets tend to fall. If you are involved in bond markets, you may want to adjust your investment plan according to rising interest rates so you don’t expose your portfolio to inflation risk.
- CD returns rise: Rising interest rates can also affect your certificates of deposit (CDs). If you have an existing long-term CD at a lower rate, you may consider withdrawing funds early (after considering the penalty charges).
- Savings account returns rise: Banks often raise savings account rates when interest rates rise. However, banks may not feel as compelled to raise rates alongside the Federal Reserve on savings accounts that already have higher rates. It might still be worth having a conversation with your banker about your savings account rates and how they may change in the foreseeable future.
- Money market account returns rise: As for savings accounts, rates for money market funds may increase too. However, a money market account often pays a greater rate of return than ordinary checking or savings accounts. In a rising rate environment, learning more about the differences between these types of accounts, and what the best option is for you, could be a very smart move.
- Mortgage costs may rise: The 30-year fixed-rate mortgage is based on the long-term prognosis for interest rates, and if interest rates climb, purchasers’ costs will rise too. Rising interest rates will not affect homeowners with existing fixed-rate mortgages. However, if you are looking to finance a new home, you may want to consider the pros and cons of a 15-year fixed-rate mortgage. While a 15-year fixed-rate mortgage will require larger monthly payments, it will offer much lower interest rates.
- Credit card debt rates rise: When interest rates rise, banks often charge clients more to borrow money. When the prime rate rises, rates on credit cards with variable APRs often rise as well. Like variable loans, if paying a large sum at once cannot be managed, then paying more than the minimum amount monthly is the best course of action. This will help you protect yourself from increasing interest rates soon.
- Your credit score may fall: Alongside the adverse effects of credit card debt and unstable mortgage rates, credit scores can also be a concern as interest rates rise. Individuals and families may find it difficult to make payments with higher interest rates, resulting in missed payments, overdue accounts, late fees, or worse. Depending on your particular case, a combination of the aforementioned steps might help you protect your credit score amidst these increases.
- Personal loan costs rise: As interest levels rise, personal loan rates rise too. If you think you might need a personal loan in the foreseeable future, it might be a good idea to secure one sooner than later before higher interest rates kick in.
It’s wise to observe that the Federal Reserve’s decisions are often based upon the nation’s changing economic situation. For example, in early 2020 they reduced interest rates to nearly zero to combat a debilitating economy due to the pandemic. In a way, this is similar to the steps they are taking now to combat inflation during the pandemic’s aftermath. Staying in the know is the best way to be equipped to prepare as the state of the economy continues to change.
In Any Environment, We Are Here to Help
As always, we do our best at Uncommon Cents Investing to keep our clients abreast of the latest changes in the economy and to equip them with the knowledge, resources, and guidance they need to protect their nest egg in any environment.
If you are looking for help with your investments and financial future, we encourage you to schedule your 15-minute complimentary call today.