7 Smartest Moves to Make Before Interest Rates Rise


By Barbara Friedberg, Contributor

If you're interested in improving how you manage your finances, then you need to care about rising interest rates that are expected this year from the Federal Reserve. The Federal Reserve controls the overnight lending rate use by banks to borrow from each other. When banks pay higher interest on these short-term loans, they subsequently charge higher interest on the money that they lend out.

According to Forbes.com:

  • Interest rates will rise for borrowers, including individuals and corporations.
  • Interest rates will rise for savers. Savers can finally look forward to greater returns on certificates of deposit and money market accounts.
  • Prices might go up due to firms' increased borrowing costs.

So there's a ripple effect from the Fed across the lending world. The prime rate, mortgage interest rates, car loan rates, CD rates and savings rates will also climb.

When will this happen? Here's what Fed chief Janet Yellen told Congress in July: "If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal-funds rate target, thereby beginning to normalize the stance of monetary policy."

Let's look at what you can do to prepare for rising interest rates.

1. Buy Real Estate

If you've been on the fence about refinancing or buying a home, vacation home or rental property, now is the time to act. Once interest rates start trending up, the borrowing costs for your real estate investment will rise.

According to Freddie Mac, the average 30-year fixed-rate mortgage has a 4.04% rate. If you borrow $200,000 for your new home, the principal and interest payment will be $959. If you wait until mortgage interest rates rise to 5.00%, the payment for that same mortgage will run $1,074.

A difference of $115 per month doesn't seem like a lot. But if you wait to borrow, in one year you'll pay an additional $1,380. Multiply that $1,380 by the 30-year term, and the delay in snaring a mortgage costs you more than $40,000.

2. Take Out a Responsible Loan

Does your business need some extra capital? Is your car due to be replaced? If you were planning to borrow responsibly in the near future, it's better to do so sooner rather than later.

If you're in the market for a car, there are some excellent car deals and financing opportunities available. The current best auto loan rates are around 2.99% APR.

If you borrow $15,000 for three years at 2.99% APR, your monthly payment will be about $436.15. If you wait and the best rates hit 4.50% APR, then your payment jumps to $446.20. That's an increase of almost $400 over the life of the loan. Waiting to borrow will cost you.

3. Refinance or Consolidate Your Debt

If you are carrying too much debt. It's usually a good policy to get that debt wiped out as soon as possible. That said, if you can't get rid of your existing debt within a short time, then you might want to consolidate your existing debt into a lower-interest package.

Just make sure that you're not extending the term of the loan and don't pay an organization to consolidate the debt for you. This tip is only viable if you end up paying less money per month and continue with a responsible repayment program.

4. Reduce Risk and Dial Back Long-Term Bond Funds

Long-term, high-yield bond funds and risky mutual funds such as junk bond funds will tend to drop in value when interest rates rise. You might want to sell these types of fixed investments and reinvest the proceeds in shorter-duration bond funds.

If you want to keep your asset allocation intact, you could trade the risky, longer-term debt for bond funds with shorter durations. Although you won't receive juicy yields from shorter-term bond funds, you'll preserve your hard-earned capital. Consider shorter-duration exchange-traded funds such as the Vanguard Short-Term Bond ETF or the Schwab Short-Term U.S. Treasury ETF.

5. Save Short-Term

How will you feel when you snare a five-year CD at 2.25% APY and in several months you find another five-year CD paying 2.75% APY? This situation is likely as you invest in a rising rate environment. The best way to circumvent this reality is to focus on short-term savings investments.

The CD ladder is a well-regarded strategy to keep your money invested now and also take advantage of future higher interest rates. If you have $50,000 cash to invest, don't put it all in a five-year CD. Divide up the money into several parts: Put $15,000 in a five-year CD, $15,000 in a three-year CD and $20,000 in a one-year CD. That way, when each CD matures, you're ready to reinvest the proceeds in a higher-yielding investment.

Or, you can just keep the money in your money market mutual fund. This investment reacts very quickly to changes in interest rates.

6. Dial Back REIT Investments

Real estate investment trusts are high-yielding mutual funds that give investors an easy way to invest in real estate. They offer high yields because they're required to pay out most of their income in dividends to investors.

The problem with REITs in a rising interest rate environment is that the underlying real estate holders will have to pay higher interest rates on their mortgage loans. When real estate companies are paying higher interest rates to borrow money, then there's less left to pay out to investors.

There's an inverse relationship between REIT prices and interest rates: When interest rates go up, the value of REIT funds tends to drop.

7. Buy U.S. Government TIPS or I Bonds

The safest investment for rising interest rates is backed by the U.S. government. The government has created a portfolio of investor-friendly savings offerings. Two of the best investments for rising interest rates are I Bonds and Treasury Inflation Protected Securities. These investments rise along with inflation.

If interest rates are going up, it's likely that inflation will also rise. So even if you buy I Bonds and TIPS today, you'll have the opportunity to watch your returns go up in the future.

TreasuryDirect.gov provides information about investing in government securities. It's easy to set up an account and invest online.

Don't Delay

If you're a borrower, don't delay. Get your loan before rates rise. Savers and investors, invest gradually to benefit from rising interest rates.

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