For the last few years, interest rates have been at historic lows. How low? Well, after adjusting for inflation, the US government is currently selling 5-year bonds at negative interest rates. This is like you borrowing $100 from a friend and having them offer to let you only pay back $90–just because! I’ll say it again: interest rates are low.
Of course, rates have been so low because we endured a terrible financial crisis and are still looking at too-high unemployment. This meant that even though many people might like to take advantage of low interest rates in theory, in practice they were unemployed, underpaid, and too busy trying to avoid foreclosure to think about borrowing more. However, the economy is improving: it’s not back to normal but it’s starting to get there. In particular, housing markets, while not fixed, have at least stopped getting worse. This means that a lot of people are starting to look at getting back in the game!
Unfortunately, with this recovery comes higher interest rates. Mortgage rates, auto loan rates, credit cards—the whole gamut of interest rates are rising and likely to keep going. This is going to pose challenges for everyone in the economy–even if you rent an apartment, ride your bike, and pay in cash, you’ll be affected! So what can you do to save money even as you’re staring at an apparent cash crunch? After a brief rundown on what will happen to your rates, we’ll lay out some tips on avoiding the rate increases you can and dealing with those you can’t.
Whenever you borrow money that you’ll later repay, there’s an interest rate involved. Even if it’s just from your family. If your parents gave you $1,000 in a pinch, and you repay them in full then they gave you a 0% loan. If you finance your car, you’ll find an interest rate in the fine print, even if they put the monthly payment front and center. So what happens when your rates rise?
Suppose you borrowed $1,000 at a 3% annual rate. That means that, for each year it takes to pay back you’ll owe an extra $30. If it doubles to 6%, you’ll now owe $60 per year. Seems straightforward, so what’s the fuss?
The fuss comes when we’re talking about bigger loans and higher rates. If you borrow $200,000 for a 30-year fixed-rate mortgage at 3%, you’re looking at under $850 a month (before taxes). If the rate doubles to 6%, you’re now facing $1,200 a month! Not impossible, but nothing to sneeze at either–I’d love to get my hands on the extra cash, and if you can ignore $350/month then you probably don’t need my advice!
On the other hand, I noted that interest rates tend to rise when the economy is doing well. The good news here is that the flipside of borrowing–saving and investing–is going to pay off more now. CDs will start to pay more, and money-market funds and other mutual funds are likely to start seeing higher returns as well. And even if you’re feeling gun shy after the recession, your vanilla bank account and safe government bonds are going to pay off more now too.
But investing isn’t the only way to take get ahead of rising interest rates. Following are our three easy steps to deal with the impending doom of interest payments in your future.
The most important thing you can do as rates begin to rise is this: lock in the lowest rate you can, ASAP! If you own your home, it’s a great time to refinance into a low, fixed-rate mortgage, especially if you’re stable and don’t anticipate moving. Refinancing from 6% to 3% would save you the same $350 that the reverse movement would cost you.
This is especially true if you currently have an ARM–an adjustable rate mortgage. Unless you’re in the teaser period, these rates will rise as their benchmark rate rises. If you’ve got an ARM, you’re going to have to start paying more. This is an excellent time to consider refinancing. If you live in a city that saw big declines in house prices–and you bought near the peak–you might not have a sufficient loan-to-value ratio (LTV) for the bank to agree. If you can, it’s worth exploring putting up a bit of cash to lower your LTV. The $350 per month from the previous example would justify even a $10,000 cash payment if you’re likely to stay in the home for a few years. I check bankrate.com regularly; it helps determine how long you’d have to stay to make a particular refinancing option worthwhile.
Is your car getting a bit long in the tooth (or the timing belt)? Interested in switching to a hybrid or plug-in EV now that gas prices are clearly never going down? This might be a great time to buy, especially if you find a deal on a model year 2013. Many companies run sales in the fall to clear out excess stock, and it’s a great opportunity to lock in a low rate. They aren’t everywhere, but you can still find a 5-year 0% auto loan if you have sufficient credit and a bit of cash down. With rates going up, it’s not the worst idea.
Relatedly, if you rent, but are considering buying, it’s a great time for that–house prices are still near historic lows, and interest rates haven’t risen too far. In many places, the recession-based damage in the housing market pushed a lot of people into renting. This pushed up the price of rentals across the country, making housing look like a particular good bet. As we’ve been noting throughout, locking in those low rates is a great plan!
Although they often have low introductory rates, credit cards have some of the highest interest rates that many people face in their day-to-day lives. Even though your credit card balance is (hopefully!) smaller than your mortgage, these high rates can have a big effect. If you’re carrying a $2,000 balance and your rate goes from 15% to 25%, you’re looking at a $200 increase annually–certainly not the same level as your mortgage, but worth paying attention to.
Finally, one trick to watch for with credit cards: 0% balance transfers. If you racked up some credit card debt due to an emergency like car repairs or a medical issue, then these balance transfers can be a lifesaver. Applying for a new card can give you a slight hit to your credit score–but the whole point of a credit score is to get you credit, and a 0% balance transfer after an emergency expenditure is an excellent use of that credit.
While rising interest rates pose some challenges, they are, on the whole, an excellent sign for the economy. Beyond borrowing and saving, they’re a sign that things are getting better. When the economy is good, you’re likelier to get more job offers, bigger raises, and a more comfortable life. And not just you, but everyone around you too–and while your mortgage bill might right a bit with an arm, the improving economy probably leaves you better off in the end.
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