As interest rates rise, find out essential financial moves to save money.
As interest rates rise, find out essential financial moves to save money.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Hello, friends and thanks for joining me this week! My name is Laura Adams and I’m a personal finance expert who’s been hosting the Money Girl Podcast since 2008.
I’m also the author of several books, including my most recent title, which was a No. 1 Amazon New Release, called Money-Smart Solopreneur–A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. If you’re building a business or want to earn more income, I hope you’ll grab a copy of the paperback, ebook, or audiobook today!
My mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress. I create every show to make sure you come away with practical advice that helps you make better money decisions and takes your financial life to the next level.
Be sure to subscribe to the show and participate by sending me your money questions or comments. You can leave a message 24/7 on our voicemail line at 302-364-0308. You can email me using my contact page at lauradadams.com or connect on Instagram @lauradadams.
Today’s episode is number 728 called “7 Smart Money Moves When Interest Rates Rise.”
The topic was inspired by a listener's question about handling a specific debt in light of rising interest rates. I’ll cover why rates are going up, six critical money considerations or moves you should make, and answer the question.
Here’s what’s happening in a nutshell: To help fight inflation, the Federal Reserve recently increased interest rates by half a percentage point, which is the largest hike we’ve seen since 2000.
They previously made a 0.25 percentage point increase in March, so we’ve seen a 0.75 percentage point total hike so far in 2022. And with inflation at a 40-year high, it’s possible that we may see more increases this year.
When interest rates go up there are winners and losers. Borrowing money gets more expensive but lending it in the form of savings means you earn more interest. So, how interest rates affect your finances depends on whether you’re borrowing, lending, or investing money. In this show, we’re going to focus on the borrowing angle.
But first, let’s quickly review how and why interest rates change in the first place. The Federal Reserve, known as the Fed, sets the federal funds rate, which is what banks charge each other to borrow money. It influences the prime rate, which influences what banks charge customers for loans and credit cards or pay them on savings. So, when interest rates change it’s a good time to reevaluate your finances, especially your debt.
So, let’s talk about six money moves you should consider!
Number one. Create or update your personal financial statement or PFS.
If you’re a regular Money Girl listener, you’ve heard me talk about a PFS. It’s a document you can create on paper, a Word doc, or a spreadsheet that lists your assets, liabilities, and calculates your net worth. It can also keep track of other financial information, such as insurance policies, emergency documents, and names of any professionals you use.
Your assets are items of value you own, such as real estate, cars, jewelry, household furnishings, sporting goods, cash in the bank, taxable investments, and retirement accounts. List every significant asset even if you still owe money for it, such as a mortgage or car loan.
Do the best you can to assign accurate market values to your assets. You can lump lower-priced items together under categories, such as furnishings; however, be as precise as possible for expensive items like real estate and cars. Once you have your assets accounted for, add up the total.
Also, consider if each of your high-dollar assets is adequately insured. I include a section on my PFS that's just for insurance policies, including home, auto, life, disability, and personal liability. Be sure to include your insurer's name, policy number, and amount of coverage you have. Remember that as your income net worth increases, so should your insurance protections.
Below your assets, list out your liabilities or what you owe, such as mortgages, car loans, student loans, personal loans, credit cards, and balances on lines of credit. For each debt, include your outstanding balance, annual percentage rate (APR), and whether it has a fixed or variable rate. Then add up your total debts.
When you subtract your liabilities from your assets, the resulting number (positive or negative) is your net worth. This exercise serves several purposes, including getting organized, understanding your savings and debt, and tracking your net worth, an indicator of your financial health.
Having all this information in one place gives you a holistic view of your finances and allows you to make the best decisions in a rising-rate environment, which we’ll cover in detail.
The second smart money move to make when interest rates rise is to pay down variable-rate debt.
As I mentioned, when you’re a borrower, rising interest rates mean you pay more. While any fixed-rate loan has a rate and payment that’s locked and never changes, variable-rate debts reset at predetermined intervals based on a financial index, such as the prime rate. So, within a month or two, your payment for them can rise or fall in step with interest rates.
So, if you have a fixed-rate mortgage, you’re safe from interest rate hikes. However, other debts, such as adjustable-rate mortgages (ARMs), home equity lines of credit (HELOCs), credit cards, and private student loans won’t be safe. Paying them down or eliminating them in order of highest to lowest interest rate is the best way to improve your finances.
The third move to make is considering refinancing variable-rate debt.
If you can refinance a variable-rate loan–such as an ARM, HELOC or private student loan–to a fixed one, that can save a significant amount of interest when rates are climbing. However, you typically need at least 20% equity in your home and a good credit score to qualify for a mortgage refinance.
If you have an ARM, review the terms to find out when and by how much your rate can go up. For example, an ARM might allow an interest rate adjustment every six months that can’t exceed 2% per year. Additionally, there are caps on how much your payment amount can go up, such as 7% over the life of the loan.
Before refinancing a loan, shopping around is critical in a rising-rate environment. Be sure you can get the lowest rate possible before making a loan commitment.
The fourth money move to make is using a zero-rate balance transfer credit card.
If you have balances on high-rate credit cards, the rate will likely get even higher as interest rates go up. An excellent strategy is to move the debt to a zero-rate balance transfer credit card. They typically lock in 0% for between 12 and 18 months.
While using a transfer card doesn’t make your debt go away, it insulates you from rising interest rates for a period. You have the opportunity to save a lot of interest and use it to pay off your balance faster. Even after paying a fee, such as 3% of the amount transferred, you can still come out ahead.
Money move number five is to finance a big purchase sooner rather than later.
If you’re ready to make a big purchase, such as a car or home, be sure to lock in the lowest fixed rate loan possible as quickly as you can. When you’re in a rising-rate environment, money is getting more expensive to borrow, so waiting means paying more.
That being said, don’t panic and make an expensive purchase just because interest rates are moving up. It still needs to fit your budget and benefit your overall financial goals.
If you plan to own a home for the long run, a fixed-rate loan that keeps your payment low, even while interest rates are climbing. However, if you plan to sell a property within a couple of years, there’s still a place for ARMs. Just remember that your interest rate and monthly payments can go up dramatically if you can’t sell the property or refinance it down the road.
And last, number six is to maintain good credit scores.
No matter what’s happening with interest rates, your credit is a significant factor in how expensive it is to borrow money. So, improving and maintaining good credit can really pay off.
Plus, a great score helps you save money in other ways, like paying less for auto insurance, home insurance, and utility deposits. It can help you get approved to rent an apartment, receive premium offers, and even land a job with an employer that checks credit.
The listener question I mentioned came from Christine H., who says, “Can you explain how interest rate hikes correlate to variable student loan interest rates? Two years ago I refinanced a private student loan for a low variable rate with a five-year repayment term. I have about $9,000 to pay off and my current variable rate is 2.723%. Would refinancing to a fixed-rate loan be helpful given the current rate hikes for such a short loan term?”
Thanks for your question, Christine! The answer depends on how high your variable rate could go. As I mentioned, most variable-rate loans come with annual caps. However, my recommendation is to contact your private loan lender and ask about the worst-case scenario and refinancing options. The lender should run some numbers for you and help determine if refinancing makes sense.
Note that if you have federal student loans, refinancing means you could give up significant benefits, such as the hardship forbearance that’s currently in place through the end of August 2022 and income-driven repayment plans. Plus, most federal loans have fixed interest rates, so they’re protected from rate hikes.
If you’re struggling to build credit, I created a comprehensive course called Build Better Credit–The Ultimate Credit Score Repair Guide. You can visit LauraDAdams.com to learn more and enroll today.
And if you’re on the socials be sure to connect with me on Twitter @lauraadams or on Instagram @lauradadams. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.
That's all for now. I'll talk to you next week. Until then, here’s to living a richer life!
Money Girl is a Quick and Dirty Tips podcast. It's audio-engineered by Steve Riekeberg with editing by Adam Cecil. Our advertising operation specialist is Morgan Christianson. And our marketing and publicity assistant is Davina Tomlin.