Linda Meltzer, Wealth of Geeks
With inflation in September still running hot at 8.2%, households tend to be the most interest-rate-sensitive sector. As borrowing costs rise, they will postpone large purchases while becoming more significant savers. We may not be able to control the economy, but we can anticipate the changing environment to better our financial health.
To fight the high inflation hurting our wallets, the Federal Reserve hiked its key interest rate five times this year, raising the Fed funds rate from near zero at the beginning of 2022 to 3.0%-3.25%.
The Fed plans more hikes in the coming months, resulting in higher consumer borrowing costs, like mortgage loans and credit cards. We asked the experts how consumers can prepare for higher interest rates and benefit from them.
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What do rising rates mean for average households?
The Fed raising interest rates is akin to firefighters putting out the flames, discouraging spending and slowing the economy. Some fear that the Fed’s actions to tighten the money supply, a reversal in its policy, may drive us into a recession again. Unemployment rates remain relatively low at 3.5%, so it may be an excellent time to spoon out this medicine.
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Consumers can benefit from rising interest rates
1. Save More Money
The US personal savings rates in August 2022 are now at a low level, 3.5%, after registering unusually high savings rates during the pandemic, when we weren’t going out and spending as much. However, we are well below the pre-Covid savings rate of 8.3% recorded at the end of 2019. Undoubtedly, higher inflation is taking a toll on our wallets and depleting our savings.
With challenging days potentially ahead, saving money remains essential. Paying yourself first is a good strategy as you fill your coffers.
2. Boost Your Emergency Savings Fund
Now is an excellent time to bolster your emergency fund or establish an account if you don’t already have one. Many believe that the Fed’s rate hikes may result in higher unemployment. Emergency savings can help you prepare for uncertain times and weather job loss, reduced hours, or lower bonuses. Plus you can save money and earn more interest from the banks.
Myra Alport, Financial Coach, Founder of Money Coach, says, “After several years of short-term interest rates paying zilch, savers are finally being rewarded in the current rising interest rate environment. So while you may be paying higher interest on credit card balances, new car payments, and mortgages, you can now reap the rewards of online savings accounts and Certificates of Deposit.
“Traditional brick-and-mortar bank savings accounts are still yielding paltry rates of less than .05% at best, nothing to brag about. Online banks have grown in popularity over the last ten years. They are safe, FDIC-insured, and have minimum balance requirements.
“You can link your primary bank elsewhere with your online savings account to transfer funds back and forth if you allow 2-3 days (excluding weekends) for processing. I suggest keeping small savings account at your primary bank for emergencies and an online bank for long-term goals, the best of both worlds.”
You can increase your emergency cushion by realizing extra savings. This is especially important if you work for an industry or business prone to recessions. As interest rates rise, banks will likely offer higher-yielding FDIC-insured saving accounts or high-yield money market accounts - perfect for your emergency fund. High-yield savings accounts from online banks may offer higher rates as well.
3. Prioritize Paying Off Debt, Especially Credit Card Balances
With higher interest rates for borrowers still coming, paying off your credit card debt will only get more costly. According to Credit Cards, the national average APR credit card rate for new users was 18.44% in late September, up from 16.25% six months ago.
Use your emergency savings to pay off your credit cards entirely. If your balances are too cumbersome, apply for a balance transfer credit card with 0% APR and a generous timeframe like 12 to 21 months to reduce your card balances.
You’ll need to reduce your spending significantly during this time and live more frugally as well.
4. Reduce Discretionary Spending
Reduce your spending significantly. Look for bargains on the things you need. Many companies discount their merchandise to get rid of bloated inventories. Ease your budget by eating more meals at home, and switch to free, ad-supported streaming services.
5. Postpone Large Purchases Like Homes and Cars
As interest rates rise, consumers typically reduce and delay spending, particularly for large-ticket items like cars, appliances, and homes, rather than take on costly loans.
Unless you find the home of your dreams, you are better off postponing purchases, as mortgage costs rise higher.
6. Buying Your Home Will Cost More, Can You Afford It
After historically low mortgage rates of 2.67% at the end of 2020, the 30-year fixed rates are now over 7% and are likely to go higher. Buying a home will cost you more.
If you’re buying a $500,000 home with a 20% down payment, your 30-year fixed-rate mortgage loan of $400,000 will cost $2,661 a month at current rates, up from $1,622 just a few months ago. Over the life of the loan, you’ll be paying $375,489 more in interest costs before refinancing your loan in the future.
Nathan Mueller, MBA, financial advisor, and Founder of BlackBird Finance, says, “If you are at the point you need to buy a home, make sure you still can afford the mortgage payment. The upside is that as demand cools, you may have more leverage in negotiating the home’s purchase price.”
7. Review Investment Strategies for Market Volatility
Panic selling in any market is the worst thing you can do. It is hard not to be emotional when the market is setting new record lows. Unless you really need the money you invested, try to weather this volatility. You can’t time the market for its bottom, but if you have a long-term timeframe, you may find some bargains in better companies.
For those experiencing sleepless nights due to this market, dollar-cost averaging, like automated savings in your retirement accounts, is a valuable strategy.
8. Proactive Moves for Investors
Investors can make proactive moves in the market.
David Edmisten, CFP, Founder of Next Phase Financial Planning, says, “Investors can look at the potential to harvest tax losses in their brokerage accounts by selling stocks at a capital loss. Investors can harvest these losses to offset realized gains in other areas of their taxable portfolio. With the stock market down for the year, it can be worth considering adding quality dividend stocks and high-quality, stable companies with consistent cash flows to one’s portfolio.”
9. Review Asset Allocation and Add Bonds
Investors avoided bonds in their portfolios for a long while because of the minuscule returns generated in a low-interest rate environment. But as interest rates rise, stocks go through correction, making Treasury securities more attractive for portfolio protection. The two-year Treasury yields have shot up to 4.22% end of September 2022, up from 0.73% at the end of 2021.
There are no better places to go for safety and high returns with high inflation than investing in Series I Government Savings Bonds, which currently pay 9.62% in annualized interest, adjusted for inflation, with a AAA rating. There is a cap of $10,000 per person on the purchase amount, but you can also buy bonds for your children. Alternatively, TIPS or Treasury Inflation-Protected bonds provide similar benefits without the cap.
You can’t stop inflation, but with careful planning, you can use it to your advantage, and ride out the storm.
