Borrowers have been enjoying historically low interest rates since the Great Recession hit. For those with solid credit histories, taking out a mortgage, auto loan or personal loan has never been cheaper. But all that could change. Rates on 30-year fixed-rate mortgages have started creeping upward, and financial experts say other forms of debt could soon follow suit.
"We do anticipate rates going up, but how far and how fast that's going to happen is an open question," says Bradley Roth, managing partner at Kattan Ferretti Financial, a Pittsburgh-based financial planning and investment advisory firm. He expects the rates on 10-year Treasurys, which are currently approaching 3 percent, to reach 3.25 percent before the end of the year and then 4 to 4.25 percent in 2014.
A rise in interest rates could soon be reflected throughout the entire financial services space, from credit cards to personal loans to home equity lines of credit. The good news for savers is that rates on deposit accounts could also climb after years of very low, or no, rates of return. Here's a roundup of how to prepare for rising rates, depending on your own money identity:
"Savers should be able to benefit," Roth says, because he expects the rates on certificates of deposit, savings accounts and money market accounts to all go up. However, he warns savers against locking up their money in longer-term products, like CDs, which can make it harder to take advantage of quickly rising rates.
Any rise in savings rates, though, will likely come slowly, says Greg McBride, senior financial analyst for Bankrate.com. "The Federal Reserve is still 18 to 24 months away from boosting short-term rates, so that will keep a lid on the savings yield," he says.
In the meantime, with deposit rate accounts still low, savers can maximize their rate of return by shopping around, says Richard Barrington, senior financial analyst at MoneyRates.com. Online banks tend to offer higher rates of return, he says, because they don't have the expense of supporting branches.
Casey Bond, managing editor of GoBankingRates.com and a U.S. News My Money blogger, also encourages people to explore local banks, which sometimes offer higher rates of return. Otherwise, she says, savers have to take on additional risk to find higher returns. When it comes to short-term savings accounts for emergencies and daily expenses, "It's better to keep [money] in short-term deposit accounts with FDIC protection," she says, even if that means foregoing higher yields.
Regardless of where you park your cash, the most important point is getting in the habit of saving, and saving as much as possible, says David Tysk, an Ameriprise (AMP) financial adviser based in Eden Prairie, Minn. That's much more important than the interest rate you are earning on your short-term accounts, he says. "Make saving as automatic as possible, so it's not up to you to save money or not," Tysk says. That way, it's less tempting to spend the money instead of putting it away, he says.
Anyone carrying credit card debt is probably paying dearly to do so, since credit cards rates have remained at relatively high levels even as other interest rates have fallen. Roth says he encourages his clients to pay off their credit cards each month to avoid fees and interest.
Other types of loans, such as auto loans, personal loans and home equity loans, have seen lower rates, and there's still time to take advantage of that, says Tommy Gletner, senior vice president and private financial adviser at SunTrust Investment Services (STI). "Anybody that's seeking to take on debt should do it now rather than later," he says, adding that borrowers should lock in current rates so they're protected from future rate increases.
Roth says he expects some volatility in the stock market as interest rates go up. "Long-term bonds and bond mutual funds will likely do poorly as we see major outflows," he says, adding that utilities, real estate investment trusts and emerging market funds could also take a hit. "We recommend keeping your bond exposure on the short end and staying diversified," he adds.
Roth says many of his younger friends and clients have the mistaken idea that bonds are a relatively conservative, safe investment. "That people think bonds are risk-free is scary to me," he says.
Tysk points out that many bond funds have been losing money since May. (Bond funds tend to lose money as interest rates climb.) Tysk says the appropriate response depends on the investor, including when he or she needs the money and what other sources of money he or she has. He encourages anyone with a retirement account to take a close look at where their money is currently invested and consider whether there are better places for their money than bond funds.
Current bond behavior is in contrast to the past 30 years, Gletner points out. "From Alan Greenspan to now, we've had a very loose and accommodative, meaning lowering rates for the economy, monetary policy. That's been very good for bonds ... You can see that coming to an end," he says.
At the same time, Gletner says, the economy could sputter and rates could fall again. "For many investors, they shouldn't eliminate bonds from their portfolios. It might make sense to simply weather the storm, because people forget to rebalance, and unless you have a lot of time to stay on top of it, it makes sense to stick with diversification, and bonds have important diversification qualities," he says. When stocks are doing poorly, bonds tend to do better, offering an essential stabilizing force. Another option, he says, is to invest in bonds that are less sensitive to interest rates, such as high-yield bonds or floating-rate bonds.
For Homeowners and Buyers
If you own a home and you haven't refinanced yet, it might be too late. "For my clients, we're not saying, 'Let's refinance today,' with a one-year high," Tysk says. He points out that according to MortgageNewsDaily.com, rates on 30-year fixed-rate mortgages are currently close to 4.75 percent, which is almost 1.5 percentage points higher than their 52-week low.
Still, in the context of history, rates are still quite low, says Chuck Schreiber, chief executive of KBS Capital Advisors. "The rate we can negotiate now is substantially below any other time in my career. The only given that we have is that we're highly confident that at some point in the future, interest rates will be higher," he says.
Similarly, if you're considering buying a home, try to speed up the process, Roth urges. "Don't drag your feet, because we'll see rates go up. You're not going to get a better opportunity to buy a house."