The Fed’s strategy to tame inflation by increasing interest rates has had widespread effects on the economy so far. The Fed began raising interest rates in March 2022, with the goal of slowing down an overheated economy by making it more expensive to buy goods and services, discouraging consumer spending and business expansion. There are signs that the policy is starting to work. Supply chains are starting to relax, and inflation is inching down. Energy prices have decreased and the housing market is cooling off, while unemployment remains low and the demand for workers continues to be high. However, the Fed is intent on seeing an inflation rate in the 2% range, so more rate increases are expected at least through the end of 2022 and possibly into 2023.
Increasing interest rates is a tightrope act. If the Fed increases rates too much and/or too quickly, it risks tipping the US economy into a recession. Some economists believe that if the economy falls into a recession, it will be short and mild. However, the uncertain consequences of the Fed’s actions have been a main contributor to market volatility.
As consumers and investors, we are experiencing the effects of the Fed’s interest rate policy in a number of ways. We may not be able to control the markets or the Fed’s decisions, but there are steps we can take to manage our finances while we wait for the economy to stabilize:
Mortgages: If you locked into a low rate on a mortgage before rates started to rise, your timing was good. The 30-year fixed rate a year ago was approximately 3%. Today, it is hovering at 6.8%. What can you do if you are locked into a higher rate? Keep an eye out for lower rates and consider refinancing. Take into account how long you plan to stay in the same house and how long it will take to recuperate the fees to refinance.
There are signs that the housing market is beginning to soften. Interest rate increases have slowed demand, which has caused inventory to increase and prices to decelerate, making it very tempting to buy into the market now. If you have just found your dream home, be sure to run the numbers on how much that mortgage payment will actually cost each month. The possibility of rate increases remains high at this point, so now could be a good time to lock in your rate. Consider making a larger down payment to lower that monthly cost but be sure to keep a cash buffer for emergency situations. Then continue to monitor interest rates in case they drop to a level where it’s cost-effective to refinance. You can find online mortgage calculators, such as on www.bankrate.com as a starting point. It can also be helpful to work with a mortgage broker as you begin the process.
HELOCs: If you are considering a HELOC, check with your lender on your options. Depending on your situation, find out if a fixed or variable rate would be more beneficial. If you already have a HELOC with a variable rate, be aware of interest rate increases and how they will affect your cash flow. Consider paying down the principal of your HELOC rather than making interest-only payments.
The positive side of interest on your mortgage and HELOC is that it may be tax deductible depending on your situation.
Credit Card Debt: Carrying credit card debt is never advised but with the average interest rate exceeding 18% and still rising, paying down and paying off that debt will save a significant amount of money. Be aware of your card’s interest rates. If you have a large balance that you can’t pay off soon, contact the credit card company to find out if lower rate options are available. Also, consider transferring your balance to a card with a lower interest rate and pay it off.
Student Loans: Interest rates on new student loans rise every year and are trending to continue to do so. If you or your child plan to take out student loans for college expenses, research the different types of loans available and compare rates among the various lenders.
Margin: For anyone who has margin on an account, expect to pay more in interest. Margin rates usually consist of a fixed rate and a variable rate that is tied to the Fed Funds rate. As with a HELOC, paying down your margin will help with those interest payments.
High Yield Savings Accounts: On a more positive note, increasing interest rates work in your favor if you have cash on hand. Research your options. Many money market funds and savings accounts are earning 2% and more!
Recent interest rate increases have been a shock to the economy and to our personal finances. Historically speaking, we have been in a very low interest rate environment for the past 15 years. However, because of current high inflation, the Fed is employing the tools it has available to stabilize prices while still attempting to maximize employment. Once the Fed determines that inflation is more under control and eases off the pedal, some economists expect that markets will stabilize, and the economy will return to a slow growth environment.