In 2009, the benchmark interest rate dropped to almost zero. This is because the U.S. Federal Reserve was exerting effort to encourage people to spend and help the economy get back on its feet after the enormous financial crisis.
The interest rate has climbed to 2.42% back in 2019 but has plummeted again due to the pandemic.
That said, it’s safe to say that interest rates will rise again. Now the question is, how will that affect your personal finances?
Before you worry about that, here’s the thing. When you hear that there’s a possibility that the Federal Reserve will increase the interest rates, there are some proactive measures that you can take to ensure that the changes will have minimal effects on your personal financial situation. Here, Bound platform shares them with you:
How an Increase in Interest Rates Affect the Economy as a Whole
Interest rates affect the behavior of buyers and sellers of goods and services. You see, if it is cheaper to borrow money, people will buy more and save less. Thus, it would be expected that there will be more demand for the goods and services they need. Consequently, there will be a shift of resources from industries that produce goods that are sensitive to interest rates to those that have goods less sensitive to interest rates.
In addition, an increase in interest rates is also expected to affect the value of the U.S. dollar. Because all assets that have interest-bearing value, such as money market funds, bonds, and bank accounts, will be worth more in U.S. Dollars, people who need or want foreign currencies will be willing to pay more U.S. Dollars to obtain these foreign currencies.
How It Can Affect Your Personal Finances
Now, how will this affect your personal finances? For example, the interest rate on the “benchmark” 10-year Treasury Note can currently be as low as 2.4%. This means that if you’re getting a fixed interest rate for your mortgage, your home loan will be $200 per month lower than it would be with a higher interest rate.
However, as the Federal Reserve increases the interest rates, you can expect your current mortgage rate to rise by around 1.6%. This will definitely be an increase in your monthly mortgage payment.
For example, if you have a $300,000 mortgage with a 6% interest rate and a term of 30 years, you can expect a monthly payment of $1,716.69. However, if the interest rate rises to 7.5%, your monthly mortgage payment will be $1,941.82.
Of course, even if you don’t have a fixed-rate mortgage, you can still expect to see the impact of the interest rates rising in your personal finances. For example, if you have a money market fund, bond, or other fixed-income security, you will see a rise in the value of your U.S. dollars. This is because while the interest rates go up, the value of U.S. dollars will go down.
What Can You Do to Minimize Its Effects on Your Finances?
You can be proactive on how to prepare for an increase in interest rates—even if you’re not sure if it will happen.
Here are some things you can do to prepare:
Reduce Long-Term Bond Exposure
Bonds are loans. As such, bonds will become more expensive when interest rates go up. The best way to protect yourself against a rising interest rate is to reduce your holdings in long-term bonds. Instead, make sure that you have a higher allocation in short-term bonds. While the returns may be smaller, you will be spared to a large extent the pain of rising interest rates.
Use Bond Ladders
A bond ladder is a portfolio of bonds in which you buy bonds with different maturities. This means that when one bond matures, another will be available to take its place. This way, you can use rising interest rates to your advantage. As interest rates go up, you will be able to sell your low-interest bonds first. While the new bonds will come with higher interest rates, you will be able to take advantage of the high-interest rates for a short period. You can then re-invest in the same kind of new bonds with the same maturities to create your own bond ladder.
Watch Out for Inflation Hedges
Inflation hedges are securities that protect you against inflation. Some of these include gold, commodities, and foreign currencies. Historically, these types of investments have been proven to be effective in times of high inflation.
Since there is a possibility that interest rates will go up shortly, it is crucial that you begin preparing for this. By taking the necessary steps now, you will be ready for a worst-case scenario and will be able to save yourself a lot of money.
Bet on Uncle Sam
If you want to beat the odds, you can bet on Uncle Sam. More specifically, you can invest in the U.S. Treasury Inflation-Protected Securities (TIPS), which are debt securities issued by the U.S. government. They are indexed to inflation, so as inflation goes up, the value of TIPS goes up as well.
Minimize Your Risk
In order to minimize the risks that you may encounter, you must adjust your investing style so as to be less sensitive to interest rate fluctuations. For instance, if you like to invest in real estate, you may consider buying a property on a 30-year mortgage. Interest rates will affect your monthly payments but not your total investment.
Pay Your Credit Card Debts
Every time you make a purchase on your credit card, you essentially borrow money from the credit card company. That, of course, is a form of debt. And while it may be expensive to borrow money, it is also a good idea to pay your debts as soon as you can in order to avoid paying penalties.
One possible side effect of the interest rate increase is that it can prompt credit card companies to increase the interest rates on their credit. Thus, it is important to pay your credit card debts as soon as you can to avoid penalty fees.
Make Sure Your Invested Cash Is Protected
In case of a disaster in the financial markets, you may want to protect the cash you have invested. An investment in gold bullion coins is one way that you can keep your cash protected.
Choose a Home Equity Loan Over Credit Lines
When interest rates go up, interest rates on home equity loans go up as well. While there are credit cards that have fixed interest rates, it is essential to take note of the fact that the interest rate on credit cards can be raised anytime. Thus, if you have a home equity loan, you can be sure that you will not be affected by a change in the interest rates. However, if you have a credit line tied to your credit score, you may want to consider paying it down immediately.
Go for a Fixed-Rate Mortgage Over an ARM
Your mortgage is a loan secured by your home. And as such, it is subject to fluctuations in the interest rates. A fixed-rate mortgage has a fixed interest rate and monthly payments. As such, it is less likely to be affected by interest rate increases.
Don’t Get Swayed by Fixed Rate Credit Cards
Some credit cards boast of a fixed interest rate. This, however, is not a fixed interest rate, as you may think. The rate is only set for a short period of time, such as six months to a year. This can mean that the interest rate can change in the future. So while you may be getting a lower interest rate now, you may end up paying more in the long run.
Refinance Your Home
What does this mean? It’s a simple concept. You can refinance it for a lower interest rate if you have a mortgage. You can then take the extra money you have to pay off your other loans. You can also opt to use the funds for other investments.
Buy a House or a Car Sooner Rather Than Later
When interest rates go up, it is more expensive to borrow money. Thus, it is expected that people will be less likely to buy a house or a car. This is because they would be less likely to qualify for a loan or afford higher payments.
This, however, can be good news for those who are in the market for a house or a car. Because fewer people buy houses and vehicles, you can get a better deal when buying one. When the market reaches its normal state, you can sell your home or car at a high price.
Work on Improving Your Credit Score
When it comes to refinancing your home, you will face competition from other people with better credit scores. Thus, you must take steps to improve your credit score. The more favorable your credit score, the better the terms of your loan are.
This is not limited to mortgages. Rather, taking these steps will be helpful for any loan you apply for in the future.
Invest In Your Retirement Account
If you have a retirement account, don’t be tempted to pull out the money and spend it because of the higher interest rates. Instead, put the money there so that it will earn you more money in the long run.
Choose a Certificate of Deposit (CD) Over a Traditional Savings Account
Some people still rely on a traditional savings account to save money. With a standard savings account, you will earn interest that is not pegged to inflation. In this case, if there is a rise in the inflation rate, your savings can decline in value. As such, you may want to consider putting money into a certificate of deposit or a CD.
As the name suggests, a CD is similar to a savings account. The difference is that you will have to lock your money for a fixed term.
When you open the CD, you will be given a certain amount of time to withdraw the money. If you fail to do so, the bank will automatically roll over your CD for another term. You can put your money into a CD as quickly as you can. If you can’t afford to tie up your money for five years, you can put it in for a shorter period. If you want to earn higher interest rates, you can choose a longer period.
However, you will be subject to penalties if you want to withdraw your money before the maturity date.
Look Into New Strategies
Interest rates are going up. As such, you may want to consider adjusting your investment strategies. At the very least, you should review your investment strategies to ensure that they remain effective in the current market. The goal is to ensure that you profit more from your investments as the interest rate increases.
The best way to ensure that your investments remain profitable is to ensure that you diversify your portfolio. This means that you should invest in different asset classes, such as stocks, bonds, and commodities. By diversifying, you can be sure that when one asset class goes down, you can count on another one to provide the returns you need.
Interest rates are rising. As such, it is best to start preparing yourself now to ensure that your investments are not affected by the rising rates. If you have not started preparing, you may want to start as soon as possible. It is a good idea for you to consult a professional financial advisor who can help you determine the best strategies that can ensure you are not significantly affected by the rising interest rates. You can also try a safe hedging platform like Bound.
Bound is a trusted hedging platform that can help protect your money from fluctuations in rates. You can use our platform to facilitate the trades you need whenever you need them. Give Bound platform a try today!