Consumers are spending more to meet the rising cost of living and the situation could get worse before it gets better.
“Even though wage growth was the best in decades, it was overtaken by rising household costs,” said Greg McBride, chief financial analyst at Bankrate.com. “With inflation at its highest level in 40 years, everyone is concerned.”
After the Federal Reserve raised interest rates for the first time in more than three years, Chairman Jerome Powell vowed to take strong action against inflation, which he said would undermine an otherwise strong economic recovery.
The central bank is now expected to hike rates by half a percentage point at its meeting this week.
“The Fed is behind, it needs to catch up, and it won’t do it in small steps,” McBride said.
This move will correspond to an increase in the prime rate and will immediately result in higher financing costs for many forms of consumer borrowing.
Where interest rates will rise
Consumers will see their short-term borrowing rates, particularly on credit cards, among the first to jump.
Since most credit cards have a variable rate, there is a direct link to the Fed’s benchmark, so your annual percentage rate will increase with each Fed move, usually in a cycle of billing or two.
Adjustable rate mortgages and home equity lines of credit are also indexed to the prime rate. Most ARMs adjust once a year, but a HELOC adjusts right away.
Since 15- and 30-year mortgage rates are fixed and tied to Treasury yields and the economy, homeowners won’t be immediately affected by a rate hike. However, anyone buying a new home is already going to pay more for their next home loan (the same goes for car buyers and student borrowers).
“The expected hike has already been priced into mortgage rates,” said Holden Lewis, real estate and mortgage expert at NerdWallet.
The average interest rate on 30-year fixed-rate mortgages rose to 5.37% last week, the highest since 2009 and is also expected to continue to rise throughout the year.
Here are three ways to stay ahead of rising rates.
1. Pay off the debt
As rates rise, the best thing to do is to pay off the debt before larger interest payments drag you down.
When looking at the debts you owe, whenever possible, pay off the higher-interest debt first, said Christopher Jones, chief investment officer at Edelman Financial Engines – and “credit cards tend to be by far the highest.”
In reality, credit card rates are currently just over 16%, significantly higher than almost all other consumer loans and could reach 18.5% by the end of the year – which would be an all-time high, according to Ted Rossman, a senior industry analyst at CreditCards.com.
If you have a balance, try calling your card issuer to ask for a lower rate, consolidate and pay off high interest credit cards with a lower interest rate. home equity loan or a personal loan or switch to an interest-free balance transfer credit card.
“Zero percent balance transfer cards are alive and well,” Rossman said, adding that cards offering 15, 18, and even 21 months interest-free on transferred balances are “a great way to save hundreds or even thousands of dollars in interest”.
Although the Fed has no direct influence on deposit rates, they tend to be correlated with changes in the target federal funds rate. As a result, savings account rates at some of the larger retail banks hovered near the bedrock, currently just 0.06%, on average.
Since the rate of inflation is now much higher than that, any money saved loses purchasing power over time.
“The worst thing would be if your cost of borrowing goes up but you don’t get a higher savings rate,” said Yiming Ma, an assistant professor of finance at Columbia University Business School.
Thanks in part to reduced overhead, the average online savings account rate is often higher than the rate at a traditional bank.
Meanwhile, high yield CD rates average over 1% – even better than a high yield savings account.
CDs that offer the highest yields generally have higher minimum deposit requirements compared to an online savings account and require longer periods to maturity. This means that the money is not as accessible as in a savings account.
“You don’t put money into emergency savings with the expectation of big returns,” McBride said. “It’s the buffer between you and 17% credit card debt when an unexpected expense arises.”
However, “if you have reserve savings, think about deposits that can be set aside,” Ma added. “Now is the time to use this rate increase.”
Generally, the higher your credit score, the better off you will be.
Borrowers with good or excellent credit (usually above 700 or 760, respectively) will qualify for lower rates and this will go a long way as the cost of finance increases.
For example, cutting a new car loan by one percentage point can save up to $50 per month, according to Francis Creighton, president and CEO of the Consumer Data Industry Association.
On a 30-year mortgage, even getting a slightly better rate can mean hundreds in monthly savings.
“For someone trying to make ends meet, it’s real money,” Creighton said.
The best way to boost your credit score is to pay your bills on time or reduce your credit card balance, but there are even simple fixes that can have an immediate impact, like checking your credit report for errors, advised Creighton.
“You want to enter the inflationary period in the strongest possible position.“