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What to do with the highest interest rate in 15 years




Editor’s Note: This is an updated version of a story that originally ran on November 2, 2022.

At the last political meeting of the year, The Federal Reserve raised its benchmark interest rate for the seventh time on Wednesday consecutively, to a range of 4.25% to 4.5%. It is the highest it has been in 1[ads1]5 years.

In a continued attempt to curb decades of high inflation, the central bank may continue to push interest rates up next year as well, albeit at a more modest pace.

This of course means higher borrowing costs for consumers. But it also means your savings can actually start earning some money after years of barely any interest.

“Credit card rates are at record highs and still rising. Auto loan rates are at an 11-year high. Home equity lines of credit are at a 15-year high. And yields on online savings accounts and CDs haven’t been this high since 2008,” says Greg McBride, financial analyst at Bank rate.

The good news: There are ways to position your money so you can take advantage of rising prices and protect yourself from their costs.

If you’ve been stashing money in big banks that have paid next to nothing in interest for savings accounts and certificates of deposit, don’t expect that to change much, McBride said.

Thanks to the big players’ paltry rates, the national average savings rate is still fair 0.19%, up from 0.06% in January, according to Bankrate’s 7 December weekly survey of large institutions.

But all these Fed rate hikes is is starting to have a much more significant impact on online banks and credit unions, McBride said. They offer far higher rates – with some over 3.75% at the moment – ​​and have increased them as benchmark interest rates move higher.

When it comes to certificates of deposit, there has been a noticeable increase in returns. The average interest rate on a one-year CD is 1.20% as of November 22, up from 0.14% at the start of the year. But top-yielding one-year CDs now offer a whopping 4.5%.

So shop around. If you’re switching to an online bank or credit union, however, choose only those that are federally insured.

Given today’s high inflation rates, Series I savings bonds can be attractive because they are designed to preserve the purchasing power of your money. They currently pay 6.89%.

But that rate will only be in effect for six months and only if you buy an I Bond by the end of April 2023, after which the rate is scheduled to adjust. If inflation falls, the price of the I Bond will also fall.

There are some restrictions: You can only invest $10,000 a year. You cannot redeem it in the first year. And if you cash out between years two and five, you lose the previous three months of interest.

“In other words, I Bonds are not a substitute for your savings account,” McBride said.

Still, they preserve the purchasing power of $10,000 if you don’t need to touch it for at least five years, and that’s nothing. They can also be of particular benefit to people who plan to retire within the next 5 to 10 years, as they will serve as a safe annual investment they can draw on if needed in the early years of retirement.

When the overnight lending rate – also known as the fed funds rate – rises, various lending rates that banks offer to customers tend to follow suit.

So you can expect to see an increase in your credit card rates within a few statements.

The average credit card interest rate hit a record 19.40% as of Dec. 7, up from 16.3% at the start of the year, according to Bankrate. Some store credit cards now have huge rates of more than 30%.

“[Interest rate hikes] will have the greatest impact on those consumers who do not pay off their credit card balances in full through higher monthly minimum payments,” said Michele Raneri, vice president of U.S. research and consulting at TransUnion.

Best advice: If you have balances on your credit cards – which usually have high variable interest rates – consider transferring them to a zero interest balance transfer card that locks in a zero interest rate for between 12 and 21 months.

“It isolates you from [future] interest rate increases, and it gives you a clear runway to pay off your debt once and for all,” said McBride. “Less debt and more savings will enable you to better withstand rising interest rates, and is especially valuable if the economy sours.”

Just be sure to find out what, if any, fees you’ll have to pay (eg a balance transfer fee or annual fee), and what the penalty will be if you make a late payment or miss a payment during the zero-rate period. The best strategy is always to pay off as much of your existing balance as possible – on time each month – before the zero interest period ends. Otherwise, any remaining balance will be subject to a new interest rate that may be higher than you had before if interest rates continue to rise.

If you don’t transfer to a zero-interest balance card, another option could be to get a relatively low fixed-rate personal loan. Average personal loans range from 10.3% to 12.5% ​​for those with excellent credit scores, according to Bankrate. The best rate you can get will depend on your income, credit score and debt-to-income ratio. Bankrate’s advice: To get the best deal, ask a few lenders for quotes before you fill out a loan application.

Mortgage interest rates have risen over the past year, jumping more than three percentage points.

The 30-year fixed-rate mortgage averaged 6.33% in the week ended Dec. 9, according to Freddie Mac. That’s more than double where it was a year ago.

“After getting above 7%, mortgage rates have pulled back a bit, but not enough to affect buyer affordability. The year-to-date rise in mortgage rates has continued to rob potential homebuyers of a third of their purchasing power, McBride said.

In addition, mortgage interest rates may rise further.

So if you’re close to buying a home or refinancing one, lock in the lowest fixed rate available to you as soon as possible.

That said, “don’t jump into a big purchase that isn’t right for you just because interest rates might go up up. Rushing into the purchase of a big-ticket item like a house or car that doesn’t fit into your budget is a recipe for trouble, regardless of what interest rates do in the future, says Texas-based certified financial planner Lacy Rogers.

If you’re already a homeowner with a variable rate line of credit and you used part of it to do a home improvement project, McBride recommends asking your lender if it’s possible to fix the interest rate on your outstanding balance, effectively creating a mortgage with fixed interest rate.

If that’s not possible, consider paying off that balance by taking out a HELOC with another lender at a lower promotional rate, McBride suggested.

Given that inflation may have peaked, market returns could improve next year, said Yung-Yu Ma, investment strategist at BMO Wealth Management. “The outlook for equity and fixed income returns has improved, and a balanced approach [in your portfolio] meaningful.”

That doesn’t mean markets won’t remain choppy in the near term. But, Ma noted, “A soft landing for the economy looks not only possible but likely.”

Any cash you have on the sidelines can be put into the stock and bond markets periodically over the next six to 12 months, he suggested.

Ma remains positive on value stocks, especially small cap stocks, which have performed better this year. “We expect the excess returns to persist going forward on a multi-year basis,” he said.

As for real estate, Ma noted, “the sharply higher interest rates and mortgage rates are challenging … and that headwind may persist for a few more quarters or even longer.”

Raw materials have meanwhile fallen in price. “But they are still a good hedge given the uncertainty in energy markets,” he said.

Broadly speaking, however, Ma suggests making sure your overall portfolio is diversified across stocks. The idea is to hedge your bets, as some of these areas will come out ahead, but not all will.

That said, if you plan to invest in a specific stock, consider the company’s pricing power and how consistent demand is likely to be for their product, said certified financial planner Doug Flynn, co-founder of Flynn Zito Capital Management.

To the extent that you already own bonds, the prices of your bonds will fall in a rising interest rate environment. But if you are in the market to buy bonds you can take advantage of that trend, especially if you buy short-term bonds, i.e. one to three years. It is because their prices have fallen more relative to long-term bonds, and interest rates have risen more. Usually, short-term and long-term bonds move in sync.

– It’s a pretty good opportunity short-term bonds, which are severely misaligned, Flynn said.

“For those in higher income tax brackets, a similar opportunity exists in tax-free municipal bonds.”

Muni rates have fallen significantly, and while they have started to improve, yields have risen overall and many states are in better financial shape than they were pre-pandemic, Flynn noted.

Ma also recommends short-term corporate bonds or short-term agency or government securities.

Other assets that can do well are so-called floating-rate instruments from companies that need to raise money, Flynn said. The floating rate is tied to a short-term benchmark rate, such as the Fed Funds rate, so it will rise every time the Fed raises rates.

But if you’re not a bond expert, you’d be better off investing in a fund that specializes in making the most of a rising interest rate environment through floating rate instruments and other bond income strategies. Flynn recommends looking for a strategic income or flexible income fund or ETF, which will hold a variety of different types of bonds.

“I don’t see a lot of those choices in 401(k)s,” he said. But you can always ask your 401(k) provider to include the option in your employer’s plan.



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