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How to Save Money When Interest Rates Go Up

By Frank Madeira, SVP of Finance, Affinity Federal Credit Union

In December 2018, the U.S. Federal Reserve (or “the Fed”) raised1 interest rates for the fourth time in 2018 while forecasting two more rate hikes for 2019. For people unfamiliar with the complexities of federal monetary policy, these announcements and the fevered commentary that they often lead to can be worrisome. “How do these decisions taken by people in Washington, D.C. impact my personal finances?” you may be wondering.

Interest Rates Go Up

In the interest of providing vital information on personal finance for our community connected, Affinity is here to offer a guide to the best strategies for how to save money in a climate of interest rate hikes – whether you’re a borrower or a saver. But first, a quick primer on interest rates and what it means when they go up or down.

A Quick Primer on Interest Rates

The role of the Fed: The Fed sets the rates that its members (credit unions and banks) charge each other to borrow funds. This has a ripple effect across all financial products that earn or pay interest. As the cost of borrowing goes up or down for credit unions and banks that cost increase or benefit is passed along to consumers.

Rising vs. falling rates: The direction of interest rates is a reflection of how the economy is doing. If rates are rising, it means the economy is doing well, and the Fed needs to slow the pace of economic activity a bit to prevent overheating (inflation). If rates are falling, it means the economy needs a boost. Lower rates stimulate economic activity by making it easier to borrow. We’re in the midst of a rising rate cycle, which means the economy is strong, and needs to slow down a bit to prevent inflation. Rates have been slowly rising since December 2015 and are expected to continue to increase through 2019.

Short-term vs. long-term rates: It’s important to understand the difference between short-term rates (under 2 years) and long-term rates (over 2 years). Short-term rates determine what you might earn on a bank deposit or pay on a credit card. Long-term rates determine what you pay on longer-term fixed rate borrowings like mortgage loans. The Fed’s actions generally only affect short-term rates. Longer-term rates are driven by the market’s consensus view of where the economy is headed. If the economy is operating normally, long- and short-term rates should rise and fall together, but not necessarily at the same pace. Even though short-term rates have risen over 2 percent in three years, longer-term rates haven’t moved up as much.

So what does this mean to consumers?

It may seem counter-intuitive, but rising rates can generally be a good thing. The Fed has recently stated2 that it believes economic activity has been rising at a strong rate and that the labor market has continued to strengthen, adding that job gains have been strong, on average, in recent months. For borrowers, they can anticipate that buying a home or car will get more expensive because monthly payments will be higher. Savers can expect to see better rates paid for their bank deposits.

How to save money in 2019: For savers

If you’re a saver, you should’ve been maximizing your returns over the last few years as deposit rates have been steadily rising.  If you haven’t maximized your returns, there’s no time like the present!  A three-account structure works best.

1. Checking Account: Keep your day-to-day cash in your checking account. Choose your checking account wisely. Focus on features – no/low fees, no/low balance requirements, no ATM charges, foreign ATM fee rebates and perks like reward points or discounts on loans. Affinity offers checking accounts with these benefits. The pros of a full-featured checking account will likely outweigh any interest you might earn on checking balances – especially if you link checking to a liquid savings account.

2. Savings Account: Cash balances above what you need to pay bills or have on hand for quick access should be kept in a savings account where you can earn interest, and transfer to/from checking as you need.  The number of transfers and withdrawals or combination of them, out of savings accounts is limited by federal banking regulations (generally 6 per month). As with your checking account, you should shop around for savings accounts that offer the best features. Affinity is a good place to start!

3. Certificate Accounts: Cash balances you don’t expect to need for a while should be kept in certificate accounts, which pay higher rates. Keep in mind they’re subject to interest forfeitures if you take out your money before the certificate maturity date. Choose the term that makes sense for you. You might even want to consider “laddering” your CDs by opening multiple certificate accounts of varying maturities based on when you’ll need your cash.

How to save money in 2019: For borrowers

If you have outstanding loans or intend to borrow, you’ve probably noticed it’s a little more expensive these days. That’s monetary policy at work – rising rates slow economic activity. Here are some strategies for different loan types.

Mortgages: If you’ve had a fixed rate mortgage for more than a couple of years, congratulations –  your rate is probably lower than current rates. If you’re contemplating financing a home purchase with a home loan, things may be a little more complicated when rates are on the move (up or down). We all want the lowest possible mortgage rate, but it’s impossible to time the market. Find the home you can afford based on current rates, and don’t focus on market movements after you’ve locked in your rate. You also need to consider other factors such as fixed or variable rates. Financing a home purchase is complicated. Reach out to a qualified mortgage lender to help figure things out.

Home Equity Lines of Credit (“HELOC”): If you have equity in your home, a HELOC may be a good option if you want to get out of higher-cost debt like credit cards. Your line is based on the equity available in your home, and is there for you when you need it.  You can opt to only pay interest when you draw on the line.  HELOC’s usually have a variable interest rate, which is subject to change when the Prime rate changes. The Prime rate is what financial institutions, such as Affinity, charge their most creditworthy customers. When shopping for a HELOC look for the best rate and no fees.

Car Loans: You’ve probably noticed that there aren’t many “zero interest” financing offers out there.  That’s because of rising rates. If you’re buying a car in 2019, your best option is to do your homework in advance. Get pre-approved by your credit union or bank before you head to the dealership. Sometimes, car dealers get paid for referring your loan to a lender, so getting you the best rates may not always be their highest priority. A lesser-known fact is that you can usually purchase Guaranteed Asset Protection (“GAP”) insurance at a much lower cost from your lender than from a car dealer. GAP protects you from getting stuck with a bill if your car gets totaled and your insurance recovery is less than what you owe the lender. It’s a wise choice if you finance with a small down payment. If you have a pre-approved offer in hand, and a fair price for GAP you may do much better when you sit down with the car dealer’s finance manager to discuss payment terms. Affinity offers GAP protection and other auto financing solutions that complement its competitive auto loans.

Credit Cards: It’s getting more expensive to carry balances since credit cards are usually tied to short-term interest rates like Prime, which has been increasing recently. Your interest rates may increase a little more in 2019. If you can’t pay off your balances, and have equity in your home, you can use a home equity loan to possibly lower the high interest credit card rates. If you don’t have access to a home equity loan, look for low rate credit card balance transfer offers, but watch for high transfer fees and high interest rates after promotional periods expire. Choose your credit card wisely.

With some simple planning and strategizing using the above tips, you can stay on the path to financial wellness in 2019.

1 2 USA Today

This information is for informational purposes only and is intended to provide general guidance and does not constitute legal, tax, or financial advice. Each person’s circumstances are different and may not apply to the specific information provided. You should seek the advice of a financial professional, tax consultant, and/or legal counsel to discuss your specific needs before making any financial or other commitments regarding the matters related to your condition are made.

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