5 Ways to Beat Interest Rate Hikes

Prices on everything from gasoline to groceries are squeezing American households. The continued inflation is forcing the hand of the Federal Reserve to hike interest rates multiple times — with potentially more to follow. So, what does that mean for borrowers and investors?

While that policy pivot is significant, Brent Weiss, co-founder of the virtual financial planning firm Facet Wealth cautions people not to overreact, either. “What we don’t want to do is chase news headlines,” he says. “You want to follow a personalized plan.”

Dramatic changes to your strategy may not be warranted. But experts say there are several adjustments you can make to head off expected rate hikes and improve your financial position. Here’s what to do.

1. Question your cash.

If your money is sitting in a bank account paying zero interest, or close to it, you’re not really treading water. When consumer prices are rising at a 6.8% annualized rate, as they are now, your bank balance is effectively losing about 6.8% of its value a year.

As Weiss succinctly puts it: “Cash is a scary place to be right now.”

Even when the Fed raises rates, it usually does so slowly. In the meantime, Weiss says you may want to rethink how much money you’re leaving in a bank account that’s losing the footrace with inflation. For younger parents in particular, anything beyond what you need for emergencies or near-term purchases — the down payment on a home, for instance — is probably better to invest.

For someone who’s been in their job for a long time, Weiss says you probably only need enough in your bank account to cover three to six months of expenses. Those in more volatile careers or starting their own business might want to increase that a bit, setting aside six to nine months’ worth. But money that you know you won’t need for five to 10 years can be put to more productive use.

“If you have excess cash, you have to ask yourself why,” says Weiss. You may want to expose that extra money to risk if it means countering inflation, he says.

2. Check out of checking.

Over the past couple years, there hasn’t been a gigantic difference between checking accounts and interest-bearing savings accounts in terms of the return on your deposit — the latter haven’t exactly offered huge payouts. But because bank interest rates are typically tied to the “funds rate” set by the Fed, that could start to change, says Matt Schaller, a St. Louis-based planner with the investment advisory Moneta.

“If you have a rainy day fund and it’s all in a checking account, it might be a good time to look for a savings account at your bank or an online savings platform,” says Schaller. Online banks like Ally and Marcus offer higher APRs than most brick-and-mortar institutions, so you’re likely to reap bigger rewards by parking your cash there.

Of course, even if rates rise, your bank deposits are likely to lag inflation by a considerable margin. So, yes, federally-insured accounts are a good place to put your emergency funds and money for near-term needs, but it’s not a place you want to keep excess cash.

3. Reduce your loan balances.

While investors and savings account holders will welcome bigger yields going forward — there’s another side to potential interest rate hikes: it may soon be more expensive to borrow.

If you have loans with fixed rates, your situation won’t change based on what the Federal Reserve does or doesn’t do. But for variable-rate debt — a category that includes many private student loans, car loans, home equity lines and credit cards — the interest you’re charged is based on market conditions.

If you have loans with a variable rate, Schaller says you’ll likely see your finance charges creep upward if Fed policymakers decide to boost the funds rate. That makes this a great time to pay down your balances — especially on loans where you’re already being hit with a hefty interest rate.

One obvious target are credit cards, which typically impose some of the highest rates of any type of debt. If you can’t afford to pay it off right away, experts suggest refinancing that balance in order to stave off huge finance charges. One way to do that is to roll your debt onto a new card with a 0% introductory rate, especially if you think you can zero out your balance within a few months. Just be aware that you’ll likely face a 3- to-5% transfer fee, and rates will soar once the preliminary period ends.

A less risky option is to take out a fixed-rate personal loan that you would use to wipe out your card balance. “It’s better than having a 15 percent APR that could eventually jump to 20 percent,” says Weiss.

4. Refinance your mortgage.

Homeowners with adjustable-rate mortgages, or ARMs, may be in for a shock if the central bank takes aggressive action to combat inflation. These loans usually start out with highly competitive rates but then “reset” to a new rate after, say, three or five years.

If the Fed pushes rates higher between now and then, the increase in your monthly payment could be even higher. Weiss says now is a good opportunity to refinance into a fixed-rate loan to spare yourself any major surprises.

While fixed-rate loans don’t always move in lock-step with the Federal funds rate, Schaller says even the APR on those mortgages could start to creep upward if above-average inflation persists. So even if you don’t have an ARM, swapping out your mortgage while rates are still incredibly low may be a good idea if you can shave enough off your payment to justify the closing costs.

Any time you apply for a big loan, Weiss says you should first give some attention to your FICO score. Paying off your revolving loan balances and making a series of on-time payments, for example, shows lenders that you’re a less-risky customer. “If you increase your credit score, your loan rates will go down,” says Weiss.

5. Review your investments

One of the axioms of the investment world is that when interest rates go up, bond prices go down. Long-term bonds tend to be more vulnerable than most in a rising interest rate environment, so you want to make sure you’re not over-exposed.

If your bond holdings are already fairly diverse — you’re invested in a broad index fund, for example — Weiss says you’re probably in pretty good shape. He notes that interest rate hikes are already priced into the market, so you’re not necessarily going to make a huge profit going all-in on shorter-term bonds right now. “The only way you’re going to get that right is if interest rates rise more than expected,” says Weiss.

Still, Schaller sees room for yields to climb even further next year. He says he’s advising most of his clients to focus on bonds that mature in a few years or less, so they can potentially turn around and buy higher-paying assets if yields continue to rise. Those who invest through mutual funds can operate on that same principle. “You can be more strategic and look at funds that focus on the duration that you’re looking for,” says Schaller.