Higher Interest Rates Are Coming: Are You Prepared?
Inflation has garnered headlines and ravaged our pocketbooks for the last year as it has trended up significantly. With the ongoing situation in Ukraine, there is a real worry that the trend will continue for a bit. Following hard on the heels of the spike in inflation has been speculation about the response from the Federal Reserve. The Fed has several tools at its command to lower inflation, and foremost of these is control over the Fed Funds rate, the key short-term interest rate for our economy. Increasing the cost puts a damper on growth and will, over time, likely bring down inflation.
The challenge for the Fed is to raise rates in a way that allows our still-recovering economy to continue to expand. Raising rates too high and too quickly can choke off growth. Raise too slow, and inflation may continue to run rampant. Chairman Powell and his Governors have tried to be as explicit as possible at signaling when and how much rates will increase. While the exact amounts and timing are dependent on incoming data, and the current situation in Ukraine will complicate things, we do have some clarity on the pace and timing of rate increases.
The Fed has been transparent that they intend to increase the Fed Funds Rate in March by 25 basis points (not the 50 basis points some anticipated), and further increases will happen consistently throughout the year. How many throughout the year is an unanswered question, but The Fed had initially signaled five increases in 2022. At a minimum, five 25 basis point increases will put the short-term rate over 1%. Bond rates are likely to increase further, particularly as maturities get longer. Mortgage rates have already increased, with Bankrate reporting an increase in the national 30-year fixed-rate mortgage, to 4.27% on March 4th, from 3.77% just a month earlier.
How should you prepare your finances and your portfolio? We have some ideas.
There’s Still Time to Refinance Your Mortgage
Rates are still historically low, and lenders are motivated to compete for your business. Yet I still talk to people who are paying hefty mortgage interest rates. If you have good credit and plan on staying in your house, it’s potentially advantageous to refinance your mortgage to a lower rate. Think about your situation. Is there a lower rate available? Can refinancing help with your cash flow? Does it make sense to either shorten or extend the length of your mortgage?
While refinancing to a lower rate can provide a good bit of savings, be careful of some of the refinancing “tricks.” When refinancing, you should consider the term of your current loan, and your refinance. Sometimes your “savings” essentially stretch your payments over a more extended period. It would help if you also looked at the closing costs. We all know that this world doesn’t offer an authentic “free lunch.” To lock in a lower rate, the mortgage company charges closing costs. Sometimes they are willing to roll them into your loan. Even if the funds don’t have to come out of your pocket at closing, you still pay, and the cost should be part of your consideration.
Is Your Debt Vulnerable on the Upside?
When rates were sliding, variable interest rate debt was a way to protect yourself. Now that the tables have turned, it’s worth it to go through the process of paying off this debt or converting it to a fixed-rate loan. This can include personal debt, leases, or credit card debt. If you have these types of debt, consider prioritizing it to pay it off as quickly as possible.
If you can’t secure other funding to pay off credit card debt, create as aggressive a payment plan for yourself as you can. Credit card debt tends to increase dramatically when rates go up, as credit card companies opportunistically increase rates and factor in increased risk as consumers may be unable to tap lower-cost sources of funding. Unless you increase your payments, you won’t be paying off as much of your balance as you were because more will be going to interest.
Shorten Your Bond Duration
Holding bonds in an investment portfolio provides both income potential and necessary ballast to counter equity volatility. The Russian Ukraine crisis has brought that reminder to the forefront. However, bond prices tend to decline as rates go up and bond prices inversely to their yields. In the current situation, with investors seeking so-called “safe-haven” assets and fleeing the risk of the equity markets, prices on bonds may be pushed up as investors increase their positions.
The key is looking at the duration of your bond positioning. Duration is a measure of a bond’s sensitivity to interest rates, and it calculates the expected price change of a bond given a 1% increase in interest rates. It is expressed in years, and bonds with longer durations are more sensitive to interest rate risk. Consider shifting your portfolio to shorter-duration bonds. Creating a bond ladder where you purchase successive maturities to not be caught behind an interest rate increase can help manage this risk.
The Bottom Line
Inflation, supply chain disruptions, and global uncertainty mean the volatility will likely continue. While it’s not quite “batten down the hatches,” it is prudent to take steps to ensure your entire financial portfolio is tuned up to stay in step with our changing economic situation and in line with your goals. If you need additional guidance, give us a call, we are happy to provide guidance.
This material is provided as a courtesy and for educational purposes only. Investing involves risk including loss of principal. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. This article contains links to articles or other information that may be contained on a third-party website. River City Wealth Management is not responsible for and does not control, adopt, or endorse any content contained on any third-party website. The information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. Past performance is not indicative of future results.