Prepare for rising rates.
The Federal Reserve has held interest rates steady so far this year, with a 30-year fixed mortgage interest rate at about 2.99%. However, as the economy continues to recover following the coronavirus pandemic, many policymakers anticipate interest rates will go up in 2022 and again in 2023. Prospective homebuyers and homeowners with variable mortgages are likely to be most affected by rising rates, and, in addition, many aspects of a family's financial life could be impacted. In order to protect your money, here's what to watch for when interest rates go up.
Variable loan costs rise.
Borrowers holding a variable prime rate loan, also known as an adjustable rate loan, will see their payment amounts rise as interest rates rise. Unlike a fixed rate loan, the cost of a variable loan can climb quickly. These loans may be mortgages, personal loans or car loans. When interest rates are poised to rise, it may be wise to convert a variable loan into a fixed loan or pay off the variable loan as soon as possible.
Bond markets fall.
Bond markets tend to fall as interest rates rise. Bond prices are generally higher this year than in 2020, as interest rates remain low and the Federal Reserve continues its purchase of bonds, but as of their last meeting in July, Fed Chair Jerome Powell said, "I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year." Bond investors can attempt to anticipate and respond to this action and interest rate hikes to manage those investments accordingly.
CD returns rise.
Certificates of deposit, or CDs, can offer better annual percentage yields when interest rates rise and be attractive to new investors. However, those holding an existing long-term CD at a lower rate may want to consider withdrawing funds early, after considering the penalty costs, when interest rates rise significantly. "For those who already have CDs who may be comparing their old CD rates to the newly increased CD rates, they may feel they are missing out," says Simon Zhen, chief research analyst at MyBankTracker.com. "One tip I have is called laddering, a strategy some people use so they're not so tempted to jump around when interest rates change and every year you are taking advantage of the highest CDs at that point in time and diversifying your CDs."
Savings account returns rise.
Banks are often inclined to raise rates of return on savings accounts when interest rates rise, but this isn't always the case. "Bank balance sheets and total deposits have bloomed to more than they know what to do with," Zhen says, citing pandemic-era stimulus payments. "While Fed interest rates may be increasing, banks might not have that same level of urgency to increase savings account rates alongside them."
Money market account returns rise.
Like savings accounts, money market funds can see a greater rate of return following an interest rate hike. Typically, a money market account offers a higher rate of return than most checking or savings accounts with lower rates of return less than 1% and high-yield money market accounts at nearly 2%.
Mortgage costs may rise.
The 30-year fixed rate mortgage is based on the long-term outlook for interest rates, and prospective buyers will see their costs rise as interest rates rise. Prospective buyers can opt for a 15-year fixed rate mortgage instead, benefiting from a lower interest rate but incurring higher payments each month under the shorter loan term. Homeowners with existing fixed rate mortgages will remain untouched by rising interest rates.
Credit card debt rates rise.
When interest rates rise, banks typically charge customers more to borrow money -- including those with credit card debt. The average credit card interest rate is 18.04% for new offers and 15.10% for existing accounts, according to WalletHub. Consumers holding a credit card with a variable APR will typically see rates rise as the prime rate rises. However, "If you have a credit card and are using it responsibly, paying off the balance every month, it should not be a major concern," Zhen says.
Your credit score may fall.
Higher interest rates can cause individuals and families holding mortgages and credit card debt to struggle as payments rise, leading to missed payments and delinquent accounts. As a result, borrowers may see their credit score fall when interest rates climb.
Personal loan costs rise.
Personal loan rates are relatively low today but may soon rise as interest rates climb in the coming years. Individuals anticipating the need for a personal loan to finance an upcoming large purchase may want to lock in lower rates now.
The Federal Reserve may act.
In early 2020, the Federal Reserve cut interest rates to nearly zero alongside other measures to support a faltering economy amid the coronavirus pandemic. This is an example of when and how the Fed can take action attempting to balance the economy, and keeping a close eye on the Fed can help consumers understand the nation's economic situation and make decisions around issues like homeownership and debt management. The Fed may raise interest rates on multiple occasions in the next few years, so consumers should watch this body to make plans accordingly.
What happens when interest rates rise.
-- Variable loan costs rise.
-- Bond markets fall.
-- CD returns rise.
-- Savings account returns rise.
-- Money market account returns rise.
-- Mortgage costs may rise.
-- Credit card debt rates rise.
-- Your credit score may fall.
-- Personal loan costs rise.
-- The Federal Reserve may act.