The days of zero rates have come to a grinding halt.
Federal Reserve officials are setting the stage for one of the most aggressive tightening cycles in decades to battle surging inflation. Illustrating the urgency, policymakers look poised to consider hiking interest rates by three-quarters of a percentage point — or 75 basis points — at their June policy meeting, which would be the biggest increase since 1994.
The ultimate question now is how high will interest rates continue to climb. If Wall Street’s views come to fruition, rates could rise to 3.5-3.75 percent target range, the highest level since the 2008 financial crisis, according to CME Group’s FedWatch. That outlook is fast evolving, with most investors betting just a week ago that the federal funds rate would rise to 2.75-3 percent by the end of the year.
Meanwhile, rates in some corners of the market are skyrocketing at a pace even faster than the Fed. The average 30-year fixed rate mortgage has risen more than 2 percentage points since December 2021. Mortgage rates have never spiked this fast before, according to Greg McBride, CFA, Bankrate chief financial analyst.
The Fed’s actions have ripple effects on every aspect of your financial life, influencing how much you’re charged to borrow and how much you earn when saving. Consumers can feel the Fed’s impact almost immediately. When the Fed’s rate rises, so too do rates on credit cards, home equity lines of credit (HELOCs), auto loans and adjustable-rate mortgages (ARM), as well as yields on certificates of deposit (CDs) and savings accounts.
There’s one bright spot to paying more for money this year: More expensive borrowing costs can also hopefully reverse today’s red-hot levels of inflation that have made it more expensive for consumers to afford everything from cars, gasoline and utilities to groceries, furniture and appliances. But the downside is that recession risks are rising, particularly considering how much higher the Fed might have to take interest rates than it previously thought.
All of that underscores the importance of getting a handle over your finances, especially to ensure you’re well-positioned to tackle the one-two punch to your cost of living that is higher interest rates and soaring prices.
Here’s your 10-step plan for taking charge of your wallet as the Fed hikes rates.
1. Get a snapshot of your personal finances
Before you form a financial action plan, consumers should get an idea of where they’re at with their personal finances, including how much they have in both savings and debt.
“Plan down to the decimal point how this will impact your budget,” says Bruce McClary, spokesperson for the National Foundation for Credit Counseling. “We don’t know exactly how many rate hikes there are going to be, but the most important thing is going into this with a clear picture of where you stand financially.”
Print out statements from any account that’s housing liquid cash — or money that you could withdraw without penalty. Those are most likely savings accounts, but they could also be funds in a money market account or no-penalty CD. Even better, make a note of each account’s annual percentage yield (APY).
Next, make a list of your current debts, including your outstanding balance and the annual percentage rate (APR) you’re charged. Keep tabs on whether that debt has a fixed or variable rate and calculate how much you spend in interest each month.
Then, consider looking at your monthly budget and expenses, including how much money flows in and out of your wallet each month.
The goal of taking a hard look at your personal finances is to hopefully inform you of how fragile you might be in a rising-rate environment. You might also be able to find the debt that’s low-hanging fruit to eliminate, as well as identify budget cuts that you can make. Individuals who live outside of their means and borrow to fund their expenses will feel squeezed in a rising-rate environment.
2. Know what’s good debt and bad debt — and eliminate the latter
If you’re a homeowner with a fixed-rate mortgage, you’ll be safe when the Fed raises rates. But consumers with variable-rate and high-interest debt will want to act fast as rates climb. They’ll be the borrowers who are hit the hardest.
“Anything you can do to pay off your balances faster and make adjustments in your budget, so you don’t have to rely on your lines of credit and carry debt from month to month, that’s the best strategy” when rates are on the rise, McClary says.
High-interest debt commonly comes from a credit card. Even when the Fed’s rate held near zero, the average credit card rate hovered slightly higher than 16 percent, according to Bankrate data. If you don’t pay off your balance in full each billing cycle, that’s likely costing you hundreds, if not thousands, of extra dollars a month.
A popular method for eliminating this so-called “bad” debt is consolidating your outstanding balance with a balance-transfer card. Once you know your monthly interest costs, compare that with any fees you could be charged to refinance that debt. Then, shop around for the best offer on the market. Most cards start borrowers out with a rate as low as zero percent for a specified number of months before transitioning them to the regular APR.
Consumers would also be wise to eliminate any variable-rate debts by refinancing into a fixed rate.
“You don’t want to be a sitting duck for higher interest rates on your credit card or home equity line of credit,” says Bankrate’s McBride. “Fixed-rate debts like mortgages and car loans that are low and mid-to-single-digit rates — there’s not a whole lot of incentive to pay ahead” when inflation is higher.
That’s because the relatively low-cost debt can be a strong hedge against inflation. And simply put, you might be better off putting that money toward other avenues that meet your financial goals — such as saving or investing — than paying it off.
“The real value of that debt will decline in an inflationary environment,” says Gary Zimmerman, CEO of MaxMyInterest. “Since debt is a liability, when the value of your debt declines, you’re making money.”
3. Shop around for the most competitive borrowing rates
Shopping around will be one of the most important steps a consumer can take in a rising-rate environment.
The average 30-year fixed rate mortgage topped 5.36 percent on June 8, according to a Bankrate survey of national lenders. The phenomenon signals that the record-low refinance rates of the coronavirus pandemic era are now in the rearview mirror. Yet, some lenders might be more inclined to offer better deals than others to separate themselves from the competition.
The Fed doesn’t directly impact mortgage rates, which are instead pegged to the 10-year Treasury rate. The same market forces influencing the Fed often steer that benchmark yield.
Mortgage rates, however, might eventually break away from the Fed. The prospect of slower growth — or worse, a recession — could weigh on the 10-year Treasury yield, which could also ultimately lead to lower mortgage rates as well.
“If the Fed overcorrects and the economy starts to slow, then mortgage rates will come back down,” McBride says. “Be careful what you wish for because an economic slowdown — or worse, a recession — isn’t fun for anybody.”
Another avenue where noting rates might be prudent: private student loan borrowers. Doing the same kind of comparison shopping might help you score the lowest rate possible before interest rates start their ascent again.
Federal student loan borrowers, however, will want to think twice about refinancing their debt. Doing so could mean giving up on important perks, such as the pandemic-era hardship forbearance. Federal student loan borrowers almost never feel any impact from Fed rate hikes because most loans have fixed rates.
4. Work on boosting your credit score
If there’s any factor that inhibits consumers’ ability to borrow cheaply more than the Fed, it’s their personal credit scores. Most of the time, financial companies save the best rate for the so-called “safest” borrowers: those with good-to-excellent credit scores and a reliable credit profile.
Improving your credit score means more than just reducing the interest you pay on credit card debt. It could also help you save throughout all aspects of your borrowing life, including on auto loans and mortgages.
To have the best credit score possible, concentrate on making all of your debt payments on time and keeping your credit utilization ratio as low as possible — the two factors with the biggest influence on how your rating is calculated.
5. Keep up frequent communication with your credit card issuers
If your credit card rate hasn’t changed after a significant improvement to your credit score, a crucial step in your financial plan should be opening up the channels of communication with your credit card issuer. Issuers might give you a new APR, NFCC’s McClary says. If they don’t, you’ll at least know it’s time to shop around or take advantage of a balance-transfer card.
“It’s sad how few people talk to their creditors when times are good because it’s when you have those conversations, you realize a lot of really great things you could be doing to save even more money,” he says.
Ahead of an active Fed cycle, it’s also worth looking over your cardholder agreement and making sure you’re aware of how your issuer calculates your APR.
Typically, rates on variable loans change within one to two billing cycles after a Fed rate hike. Credit card companies, by law, have to give cardholders a 45-day notice if they’re going to increase their cardholder’s interest rate. Yet, any rate increase is up to the creditor, meaning it’s not outside of your issuer’s purview to hike rates faster or sooner than the Fed.
“Credit card companies do have some latitude in deciding when and how much to increase a cardholder’s interest rates within the confines and constraints of the Card Act,” McClary says. “It’s in those areas that the details are going to be in the cardholder agreement.”
6. Don’t let low yields and high inflation keep you from saving
Next-to-nothing savings yields and soaring inflation might make consumers hesitant to sit on large piles of cash, but experts say it’s more important now than ever. In fact, the outlook might look even brighter once the Fed starts dialing back stimulus, especially if it slows inflation.
“If your cash has been in a savings account at 0.5 percent for the last two years, there’s no sense moving it now while we’re on the cusp of rates starting to move up,” McBride says. “That’s like wearing your seatbelt when the car is in the garage and taking it off once the car is on the road.”
An important part of any financial plan is having cash for emergencies. Experts typically recommend storing between six to nine months’ worth of expenses in a liquid and accessible account. That balance was never meant to bring you a hefty return.
“Building a rainy day fund is really important, even if the interest rate you’re earning on those funds is lower than the inflation rate,” says Mike Schenk, deputy chief advocacy officer at the Credit Union National Association. “Put a little bit into a savings account over time, and before you know it, you’ll have a chunk of savings that can give you a better night’s sleep at the very least.”
Better yet, think about your emergency fund as the difference between having to pay for unplanned expenses with a high-interest credit card.
“In that respect, cash is earning you a risk-free 16 percent,” Bankrate’s McBride says.
7. Look around for the best savings yields
Be prepared to shop around regularly for the best savings yields on the market, even if it means moving your funds to a different bank to capitalize on a better return.
You shouldn’t sacrifice liquidity for yield chasing, but if an account on the market offers terms that fit your financial needs, nothing should stop you from going for it.
“Every month, a different bank is going to have the best rate,” MaxMyInterest’s Zimmerman says. “Since an FDIC-insured savings account is a commodity, it doesn’t really matter which bank. The whole idea of, ‘I’m going to pick a bank,’ That doesn’t make any sense.”
8. Start recession-proofing your finances
Saving is crucial right now because it highlights the ultimate risk if the U.S. central bank gets rates wrong: It could ultimately end up slowing down economic growth, or worse — causing a recession.
“Raising interest rates is putting the brakes on the economy,” Bankrate’s McBride says. “The harder they press the brakes, the sharper it’s going to slow down. The cumulative impact of ongoing rate hikes is where you’re likely to see a slowdown in economic activity and the labor market.”
Recessions aren’t always as severe as the coronavirus pandemic, the Great Recession or even the Great Depression almost a century ago. They do, however, mean increased joblessness, reduced hiring and market volatility.
All of that means it’s important to start thinking about how you’d stay afloat in a recession. The same financial advice for preparing for a rate hike applies here: Live within your means, eliminate your debts and make sure you’re able to cover a period of joblessness.
9. Think about your career and income opportunities
When the cost of living rises, one of the best investments you can make is in yourself. Think about ways that you can increase your earnings opportunities over your lifetime, whether that’s by getting more training, education or increasing your skill sets. Joblessness is typically lower for those with a bachelor’s degree or higher — even during recessions, according to data from the Labor Department.
“You have to be looking down the road because what’s far more impactful to household finances than an increase in interest rates is a job loss or a significant decline in wealth,” McBride says. “Those are the types of things that happen in a recession.”
10. Tune out market volatility if you’re investing for the long term
Higher rates typically cause market dysfunction. That’s partially by design: When the Fed raises rates, it wants to tighten financial conditions, soaking up extra liquidity in the marketplace.
Case in point: The S&P 500 closed in bear market territory on June 13 and is down nearly 22 percent since the beginning of 2022.
Still, that shouldn’t mean anything for long-term investors, especially those that put money into the markets by way of a retirement account. If you’re investing over a time horizon that spans decades, you’ll no doubt have to endure both booms and busts.
Remember: Downdrafts in the market are a powerful buying opportunity. Investing can also help you beat inflation, though it’s something you should think about mostly after you start saving.
“Investing does make sense because you will more than likely have to take a little bit of risk to earn returns that are higher than the inflation,” CUNA’s Schenk says.
The ultimate goal with rate hikes is to give the economy a soft landing — slowing inflation, but not too much that it tips the economy into a recession. But for U.S. central bankers, that might be one of the most difficult jobs yet.
“The crisis is easing, so it makes sense to take the policy foot off the gas to a certain extent, and maybe even to start tapping the brakes,” Schenk says. “It’s a very tricky balancing act. They’re basically operating on a knife’s edge.