5 Ways to Beat Upcoming Interest Rate Rises: Money Management Tips

Prices for everything from gas to groceries are squeezing American households. And, contrary to early assurances, it appears that this latest bout of inflation is not so temporary after all. This forces the hand of the Federal Reserve, which signals that it will put the brakes on the economy as soon as possible. It recently announced plans to accelerate the end of its bond-buying program, designed to boost lending at the worst of the pandemic. The Fed has simultaneously forecast up to three interest rate hikes this year, with potentially more to follow.

So what does this mean for borrowers and investors?

While this political pivot is important, Brent Weiss, co-founder of virtual financial planning company Facet Wealth, warns people not to overreact either. “What we don’t want to do is chase headlines,” he says. “You want to follow a personalized plan.”

Dramatic changes to your strategy may not be warranted. But experts say there are several adjustments you can make to avoid expected rate hikes and improve your financial situation. Here’s what to do.

1. Question your money.

If your money is sitting in a bank account paying little or no interest, you’re not really treading water. When consumer prices are rising at an annualized rate of 6.8%, as they are now, your bank balance is effectively losing about 6.8% of its value per year.

As Weiss succinctly puts it: “Cash is a scary place right now.”

Even when the Fed raises rates, it usually does so slowly. In the meantime, Weiss says you might want to rethink how much money you’re leaving in a bank account that’s losing the race with inflation. For new parents in particular, anything you need for emergencies or short-term purchases — the down payment on a house, for example — is probably best invested in.

For someone who’s worked a long time, Weiss says you probably only need enough money in your bank account to cover three to six months of expenses. Those with more volatile careers or starting their own business might want to bump that up a bit, setting aside six to nine months. But the money you know you won’t need for five to ten years can be used more productively.

“If you have excess cash, you have to ask yourself why,” Weiss says. You might want to put that extra money at risk if it means fighting inflation, he says.

2. Check out.

Over the past two years, there hasn’t been a huge difference between checking accounts and interest-bearing savings accounts in terms of the return on your deposit – the latter haven’t exactly offered huge payouts. But since bank interest rates are generally tied to the “funds rate” set by the Fed, that could start to change, says Matt Schaller, a St. Louis-based planner with investment consultancy Moneta.

“If you have a rainy day fund and everything is in a checking account, it might be time to look for a savings account with your bank or an online savings platform,” Schaller says. Online banks like Ally and Marcus offer higher APRs than most physical institutions, so you’re likely to reap bigger profits by parking your money there.

Of course, even if rates go up, your bank deposits are likely to significantly lag inflation. So, yes, federally insured accounts are a good place to put your emergency cash and cash for short-term needs, but it’s not a place you want to keep excess cash.

3. Reduce your loan balance.

While investors and savings account holders will welcome higher returns in the future, there is another side to potential interest rate hikes: it could soon be more expensive to borrow.

If you have fixed rate loans, your circumstances won’t change based on what the Federal Reserve does or doesn’t do. But for variable-rate debt — a category that includes many private student loans, car loans, home equity lines, and credit cards — the interest you’re charged is based on market conditions.

If you have variable-rate loans, Schaller says you’ll likely see your finance charges climb if Fed policymakers decide to raise the funds rate. So now is a great time to pay off your balances, especially for loans where you’re already hit with a high interest rate.

An obvious target are credit cards, which typically charge some of the highest rates on any type of debt. If you can’t afford to pay it off right away, experts suggest refinancing that balance to avoid huge finance charges. One way to do this is to transfer your debt to a new card with an introductory rate of 0%, especially if you think you can wipe out your balance within a few months. Just be aware that you will likely face 3-5% transfer fees and rates will skyrocket once the preliminary period is over.

A less risky option is to take out a fixed rate personal loan that would be used to clear your card balance. “That’s better than having a 15% APR that could eventually go to 20%,” Weiss says.

4. Refinance your mortgage.

Homeowners with adjustable rate mortgages, or ARMs, could be in shock if the central bank takes aggressive action to fight inflation. These loans usually start out with very competitive rates, but are then “reset” to a new rate after, say, three or five years.

If the Fed pushes rates higher by then, your monthly payment increase could be even higher. Weiss says now is a good opportunity to refinance into a fixed rate loan to save yourself from major surprises.

While fixed-rate loans don’t always track the federal funds rate, Schaller says even the APR on those mortgages could start to climb if above-average inflation persists. So even if you don’t have an ARM, swapping your mortgage while rates are still incredibly low can be a good idea if you can lower your payment enough to justify the closing costs.

Whenever you apply for a big loan, Weiss says you should first pay attention to your FICO score. Paying off your revolving loan balances and making a series of on-time payments, for example, shows lenders you’re a less risky customer. “If you increase your credit score, your loan rates will decrease,” Weiss says.

5. Review your investments

One of the axioms of the investment world is that when interest rates rise, bond prices fall. Longer bonds tend to be more vulnerable than most in a rising interest rate environment, so you need to make sure you’re not overexposed.

If your bond holdings are already fairly diversified — you’re invested in a broad index fund, for example — Weiss says you’re probably in pretty good shape. He notes that interest rate hikes are already priced into the market, so you’re not necessarily going to make a huge profit by going all-in on shorter-dated bonds right now. “The only way to do that is if interest rates rise more than expected,” Weiss says.

Still, Schaller sees room for yields to climb even higher next year. He says he advises most of his clients to focus on bonds that mature in a few years or less, so they can potentially turn around and buy higher-paying assets if yields continue to rise. Those who invest through mutual funds can operate on this same principle. “You can be more strategic and look for funds that focus on the duration you’re looking for,” says Schaller.

Stephen V. Lee