Interest rates have increased and are expected to continue rising, but there are various strategies you can adopt to cope with it. Advisors say there is still time to get your financial affairs in order before rates climb even higher.
What to Do About Credit Card Debt
Credit card interest rates are among the highest rates you will pay, and higher rates will cost you more in the long run. Therefore, it makes financial sense to pay down the balance, or at least as much as possible, to reduce the overall amount.
Many people may have a “financial headache” because they are no longer receiving the government payments they previously did and are now relying on their credit cards. Craig Bolanos, CEO of a wealth management group, says, “It can spiral out of control quickly.”
Bolanos states that it does not matter how you pay down your credit card debt – whether by the “snowball” method of eliminating the smallest debts first, or the “avalanche” method of targeting debts with the highest interest rates first. What matters is that you try to eliminate them.
If it’s impossible to eliminate all of your credit card debt, another strategy is to consider refinancing or consolidating debt. If you have a very good or exceptional FICO score (at the upper range of 700 to 800), one of these steps may give you an interest rate lower than what you currently have, according to McLarty.
But be sure to shop around and get the best deal, he added: “This is the hardest part and takes time. You can’t do it quickly, so start now.”
What to Do About Mortgages
To make matters worse, the central bank’s benchmark interest rate affects mortgage rates, which have already been rising on their own without the help of the central bank.
It’s already too late to take advantage of the very low mortgage rates that prevailed earlier in the pandemic era. With mortgage rates rising to their highest levels since 2019 in recent weeks, mortgages are becoming less and less affordable day by day. For example, the average interest rate for a 30-year fixed mortgage was 4.77% on Thursday, well above the low point of 2.89% it hit in December 2020, according to data provided to The Balance.
Even small increases in mortgage interest rates can add substantial amounts to the cost of buying a home. For instance, the monthly payment for a home priced at the current median value of $350,300 for a 30-year fixed mortgage at 3% would be $1,182, but it would jump to $1,338 if rates increased by just one percentage point to 4%. This means there is pressure on anyone shopping for a home.
Jim Queiroz, a financial planner at FBB Capital Partners, stated, “It makes sense that if they are in a position to make a purchase, they should do so sooner.”
Higher prices especially spark the desire to refinance, which only makes sense for homeowners looking to secure a lower interest rate. Due to all the recent borrowing cost increases, mortgage giant Fannie Mae reported on Thursday that only 13.1% of homeowners could lower their rate by half a point through refinancing.
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In reality, refinancing has dropped by 49% compared to last year, according to the Mortgage Bankers Association, which stated this week.
For those who already own homes, the major risk from rising prices is if you have an adjustable-rate mortgage. When interest rates rise, the interest rates on your mortgage will also increase, meaning you’ll start paying more interest with each monthly payment.
What to do about student loans
Advisors say individuals with federal student loans, which typically feature relatively low fixed interest rates, should not be tempted to refinance with a private lender. Federal loans come with many benefits that you will lose if you do so.
Among the main advantages of federal student loans are reasonable repayment options. For example, those who do not have enough income may choose an income-driven repayment plan. This plan will set monthly payment amounts at a reasonable level, based on annual legislative income and family size.
Additionally, repayments on federal student loans have been suspended since March 2020 and will not resume until after May 1, with the possibility of this date being extended again. Polanos stated, “There’s an external opportunity with the way political parties are trending; you could get a clean slate.”
However, private loans are completely different. If you have a low fixed interest rate on your private student loan, nothing will change regardless of how many times the central bank raises interest rates. If you have a variable interest rate, you should seek to refinance and secure a low rate now just as you would with a mortgage loan. If you’re struggling with your payments, “work with a consolidator to merge your debts and take control now,” according to Polanos.
Big purchases
If you are considering making a big purchase like a home or a car to take advantage of interest rates before they rise, opinions differ on whether you should take this step now or wait.
Dana Peterson, chief economist at the Conference Board, said, “Some people may need to buy now before rising interest rates,” although many things that you may buy on credit—such as cars—are quite expensive right now.
But McLary warned that if the purchase is not necessary, the likelihood of higher prices is not “a reason to start spending when you don’t need to.” He emphasized that a series of interest rate increases over time will not be “a huge change that disrupts budgets” immediately.
He said, “Even after the first interest rate increase, there is time to adjust and strategically plan how to buy in the future and how it fits into your budget. It’s not a good idea to go into a buying frenzy instead of restructuring the debt you already owe. If you’re thinking of a big purchase that requires financing, consider the timing of it and its urgency. That makes more sense.”
As part of that, do the math yourself and keep thinking about what you are buying. For example, if you’re aiming to purchase a $30,000 car and interest rates rise by 1%, you might only pay a few hundred dollars extra for the car over five or six years, according to Lee Baker, owner and president of Apex Financial Services. But what if the actual value of the car is closer to $25,000, away from the inflation and chip shortage that drove car prices up last year? You might want to wait until the chip shortage eases and prices drop again, as the price difference will offset any 1% or 2% rise in finance costs.
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It may be different for the home. With the current housing shortage, prices may not drop much, so instead of waiting, it’s better to secure a low-interest rate now.
Savings
One of the positives of high interest rates is that you will see an increase in the interest earned on your savings, but you need to make the most of your plans to take advantage of it. If you are investing in a certificate of deposit, advisors recommend investing in short-term certificates to benefit from every rate hike made by the central bank in this cycle.
Bolanus said: “Do not renew a certificate of deposit for 18 months. Deposit rates are likely to increase more by the end of the first quarter, so do short-term renewals and start creating a ‘ladder of certificates of deposit’ to ensure you benefit from the highest rates – renewing at higher rates.”
The ‘ladder of certificates of deposit’ will be a saving strategy where you invest a sum of money in a number of bank certificates with different maturity dates, which means they will mature at different times. When each certificate matures, you can use the cash for other purposes or reinvest it in new certificates of deposit.
In the end, McClary said that high interest rates won’t be a major problem for most consumers this year – but not for everyone. He stated: “It’s not the end of the world, but if you have credit card debt and carry a balance each month, it’s likely to cost you a little more. Those who should be more concerned are those living on the edge of poverty, where getting every dollar is hard, and every dollar must fit somewhere.”
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Source: https://www.thebalancemoney.com/higher-interest-rates-are-coming-heres-how-to-prepare-5218226
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