A two-year era of record-low interest rates is about to end, perhaps as soon as next month. That means the clock is now officially ticking, both for borrowers and savers.
The Federal Reserve is weighing when it will begin increasing the federal funds rate this year, and how aggressive it will be in doing so to tame inflation that’s running at a 40-year high. In a statement following the central bank’s policy meeting in January, Fed officials said a strong labor market and high inflation warrant a rate hike ‘soon.” Traders see a greater-than 95% probability the Fed will do so at its next meeting in mid-March.
The first rate hike is symbolic; it marks the end of the near-zero rate environment the Fed implemented in the early days of the Covid-19 pandemic. What’s more significant, however, is that policymakers will likely continue raising interest rates this year. Several banks on Wall Street are projecting a total of five rate hikes, which would bring the federal funds rate to as high as 1.5% by year-end.
What does this mean for you? There’s one potential item on your personal finance to-do list that you may want to tackle ahead of the Fed’s next meeting. More broadly, however, you’ll have some time to prepare your finances. “You don’t need to go shoot from the hip and make rash decisions,” advises Robert Gilliland, managing director and senior wealth advisor of Concenture Wealth.
In order of priority, below are five smart money moves you may want to consider.
1. Refinance your mortgage
Interest rates are headed higher, even if no one knows exactly how high, so borrowers should take advantage of record-low rates now. “The window is closing for homeowners to be able to refinance at these rates,” Gilliland says, adding that he still encounters clients who have mortgages with rates above 4%. The interest rate on a 30-year fixed-rate mortgage is currently 3.55%, according to Freddie Mac.
Shopping around for a mortgage refinancing option could save yourself a lot of money over the long run. Nearly 6 million qualified homeowners who have at least 20% equity in their home and a credit score of 720 or higher could save an average of $275 each month, according to a study by Black Knight, a mortgage data provider.
Homeowners with an adjustable-rate mortgage could potentially save even more money immediately — the rate for a 5/1 adjustable-rate loan is currently 2.7% — though you should also consider the risk when that term is up and rates are likely to be higher, Gilliland says.
One or two rate hikes aren’t likely to make-or-break your budget, but a 0.25 percentage point difference can add up for someone with a mortgage of $500,000, notes Alec Quaid, a certified financial planner at American Portfolios. While home prices are high in many areas of the country, borrowing rates will only get more expensive — and that was the push he and his wife needed to finally “bite the bullet” and buy their first home in the Denver area earlier this year.
“I don’t think someone who’s not in a position to buy should look to buy just because of this rate increase, but if you’re wishy washy and potentially looking at buying and in a position to buy, this could be a great kick in the butt,” Quaid says, adding that waiting another year to buy could mean mortgage rates that are more than 1 percentage point higher.
2. Pay off high interest debt
Next up? Tackle any debt with adjustable interest rates, such as credit cards. If you have padded your savings in the past two years, as many Americans have, now may be a good time to use your savings to pay down high-interest debt, Guilliland recommends.
With borrowing rates going up, anyone who isn’t paying a credit card in full can fall further behind, he says. “A $1,000 payment is going to pay down less of the principal you owe."
What’s more, if you’re among the 43 million-plus Americans with student loan debt, you may want to consider refinancing at lower rates. That said, other factors make this decision a bit trickier because the forbearance on student loan payments is set to expire in May and there’s a lingering prospect of broad forgiveness, Quaid says.
If you have federal student loan debt, carefully consider whether it makes sense to refinance to private loans since you’ll lose some benefits — such as the option for an income-driven repayment plan, Quaid says. “It’s easy to chase the lower rate because it looks better, but you have to peel back a few more layers before making a decision purely based on rates.”
3. Consider big purchases coming up
Quaid already was considering buying a home, though the prospect of higher borrowing costs did expedite that decision. When thinking about other big spending decisions, the prospect of higher rates is just one of many factors to consider, he says.
Guilliland agrees that you shouldn’t rush a big spending decision — such as buying a home or a car. Even so, the timing of that purchase could matter. “Figure out where financing is today and where it may be down the road.”
4. Adjust your investment portfolio
Don’t completely wipe out your savings because you may want to invest that money in the stock market — or to prevent making a “poor” decision like selling amid what’s already shaping up to be a volatile period in markets, Guilliland recommends.
Now also is a good opportunity to review your portfolio, Guilliland advises. For example, opt for bonds with a shorter duration so you don’t lock in at low rates for a long period of time and consider investing in shares of financial companies, because rising interest rates are “really, really good” for this industry, he adds.
More broadly, there may be some opportunities to buy stocks at lower prices. “Volatility can be difficult to stomach in the short-term, but it’s your friend in the long-term,” Quaid says.
5. Shop around for a better savings account
As soon as the Fed does start raising interest rates, savers will be able to earn more money on their deposits. Quaid encourages all of his clients to opt for a high-yield savings account, particularly for an emergency fund. While higher interest rates will be a nice bonus, the real goal of this money is to have cash on-hand when you need it, he adds.
Even with the prospect of multiple rate hikes this year, savers need to be patient. “It will be quite some time before higher rates on money market and savings accounts are going to be impactful,” Guilliland says.
Finally, remember that while rising rates and higher inflation may be the topics du jour, you need to understand how a broader trend affects you before taking action, Quaid advises. “It’s easy to get caught up in the hysteria, but not everyone should.”