Miranda Marquit isn’t one to sit idle. When interest rates were at record lows several years ago, she and her husband refinanced their mortgage for a savings of $300 a month. They also bought a car three years ago and with their excellent credit, snagged a five-year auto loan at 1.99 percent.
Now, with interest rates likely to rise in the not-too-distant future, they are about to take action again. “We’re thinking of replacing our second car, which is seven years old and paid off,” says Marquit. “We plan to buy a new car before rates head higher. Now is a good time to lock in low rates.”
After the financial crisis of 2008, the Federal Reserve set its short-term interest rate target near zero in the hopes that loans would be cheaper for borrowers and that the housing and stock markets would stabilize. “The conventional thought is that low interest rates encourage consumers to purchase more, which will eventually help economic growth,” says Jeremy Crimmel, an economics instructor at La Salle University in Philadelphia.
For now, interest rates remain low and mortgage rates have actually dropped recently: The average rate for a 30-year fixed rate mortgage fell to 4.14 percent for the week ended May 22, the lowest rate since October.
The Fed intends to end its tapering program by the end of 2014 and could start raising rates in the middle of next year. The market is usually well ahead of the Fed, however, and rates will likely rise before the Fed starts raising its key rate, predicts JJ Feldman, managing director and partner of Miracle Mile Advisors, a registered investment advisory firm based in Los Angeles.
The days of 3-to-4 percent mortgages could be a distant memory before long; so here’s what you should do ahead of a rising interest rate environment:
Pay off credit card debt. Carly Fauth isn’t going to give lenders the pleasure of charging her more for what she already owes on her credit cards. “With the possibility of interest rates rising, I’m addressing this now,” she says. “I’m sending in an extra $150 on my credit card debts. My goal is to have it paid off in a year.”
Particularly if you have any credit cards with zero percent introductory rates, take note of when that period expires and satisfy the debt before it does.
“This year may be the last hurrah for paying down variable-rate credit card debt with the tailwind of lower interest rates, rather than the headwind of rising rates,” says Greg McBride, chief financial analyst with Bankrate.com. “It won’t be surprising if credit card rates go up within the next 12 months. You better have a game plan for paying it back.”
Refinance your loans. Whether it’s a mortgage or a car loan, now is likely the time for getting rock-bottom rates. But first calculate whether it’s worth it to refinance. Typically, if you can get lower your rate by a full percentage point, it likely is.
Refinancing is also a good idea if you have a variable-rate loan that could leave you vulnerable in an environment of rising rates. Instead of a current floating-rate loan, switch to a 15- or 30-year fixed rate.
“Many lenders offer loans where closing costs are rolled into the cost of the mortgage so the borrower doesn’t even have to take any money out of their pocket in order to save,” says John Walsh, president of Total Mortgage Services.
Rethink bonds. “The seemingly safe bond market can become a financial minefield as rates rise,” says Dan White, a certified financial planner with Daniel A. White and Associates in Glen Mills, Penn.
Many people don’t realize that if interest rates rise, the price of bonds and fixed income funds will drop. Last year the Financial Industry Regulatory Authority said that a 1-percent increase in interest rates would typically cause a 10-percent decrease in a typical bond fund with mostly 10-year bonds, warns David Shucavage, president of Carolina Estate Planners.
Some people, especially those close to retirement or already retired, have moved 50 percent or more of their funds to bonds because those are considered safe. “That portion of their portfolio could now drop 15 to 30 percent,” he adds.
Bond investors should consider shortening the duration in their bond portfolio to lessen risk, as well as laddering maturities. “Long-term bonds are most susceptible to loss of principal, especially in a rapidly rising rate environment,” says John Piershale of Piershale Financial Group in Crystal Lake, Ill.
Review your investments. Higher interest rates may sting your investments beyond bonds. As interest rates in the Treasury market rise, the relative attractiveness of high dividend-paying stocks, real estate investment trusts, preferred stocks, and other yield substitutes may lose some of their value, says Wayne Schmidt, chief investment officer at Gradient Investments. “Look at your entire portfolio and identify your income generating assets – and realize higher interest rates may impact more than just your bond holdings.”
Take action on big ticket items or investments. If you’ve been contemplating buying a home, or a new car, it’s not going to get cheaper. Get off the fence.
Capitalize on the increase. There is a little something for savers to cheer. Those pathetic interest rates that have been just slightly better than sticking your money under your mattress should start to go upward.
“Investors who hold certificate of deposits should check renewal dates,” says Linda Hooks, PhD., professor of economics at Washington & Lee University in Lexington, Virginia. “Any that will roll over soon could be moved to shorter-term CDs and then reinvested later at a longer term if interest rates rise later.”
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