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High Rates - Now What? Thumbnail

High Rates - Now What?

Financial Planning

By: Chrissy Israel - Financial Planner

     Lance C. Steiner, CFP® - Assistant Director of Financial Planning & Senior Financial Planner


When you turn on the news, one of the first things you are going to hear about is interest rates. The Federal Funds rate reached its highest since 2001 at a range of 5.25-5.50% in an attempt to lower current inflation. What does this mean for you? That largely depends on whether  you are a depositor or a borrower.

Savings

In 2022, we wrote a newsletter that discussed what to do with your savings in high interest rate environments. It’s a good time to revisit some of those suggestions with rates at all-time highs. 

Certificate of Deposits

A low risk option to consider when wanting to earn more than your typical savings account is a Certificate of Deposit (CD). Banks, credit unions, and other financial institutions offer CDs with maturities that range from 6 to 60 months. Right now, 6-12 month CD rates are ranging from 4-5.25% Annual Percentage Yield (APY). Longer term options, ranging 18 month and more, are closer to the 4% option right now. For anyone considering CDs, we suggest a short-term ladder, which is a strategy where an investor purchases several CDs with different maturities. For example, purchasing a 6-month, 12-month and 18-month CD.  As the CDs mature, investors receive their principal and have the option to immediately purchase a new CD. This strategy will help provide liquidity at short-term intervals and allow investors to reinvest at higher rates, assuming rates continue to rise.  

High-Yield Savings Accounts

High-Yield Savings accounts are another low-risk option offering a modest return while retaining liquidity. Currently, the annual rate on a high-yield savings account is around 4-5% APY.  This type of account may be an attractive option for an emergency savings account or accumulating cash for a short-term goal, such as a down payment on a home. Not all banks or financial institutions will offer a competitive high-yield savings account and many do have an online presence rather than your traditional brick and mortar location. It is important to confirm the financial institution is FDIC-insured before making any deposit.    

Money Market Funds

A Money Market Fund is a mutual fund that invests in highly liquid, near-term instruments. These can include, cash, cash equivalent securities, and short-term debt-based securities, such as U.S. Treasuries. The rates on a Money Market Fund are backed by its underlying securities. This means they will offer a variable rate that changes based on the performance of the securities. Currently, they are offering around 4% - 5%. They are intended to offer a highly liquid account with low risk. It is important to discuss all the qualities of a money market fund with your advisor, as these are backed by an investment fund company and do not offer FDIC insurance. 

Debt

While the savings rates are attractive to take advantage of, higher interest rates also mean higher lending rates. There are a couple of items to consider when reviewing debt in a high interest rate environment. 

Type of Debt

Everyone at some point in their life has come across debt. There are two types of debt that you can obtain, secured or unsecured. A secured debt is backed by an asset used as collateral that is pledged to a lender. Examples being a mortgage, car loan, or downpayment-required credit card. This type of debt is less risky to a lender and typically offers a lower interest rate. An unsecured debt is backed by good faith in repayment from the borrower to the lender. Examples being a credit card or unsecured loan, which is commonly called a signature loan. This type of debt can be quite costly as it can have a higher interest rate due to being more of a risk to the lender.

Planning with Debt

Depending on what type of debt you have right now, it’s important to consider how the debt fits in your financial picture. If you have low interest debt right now, such as a mortgage, auto loan or zero interest credit card, you may want to consider accumulating assets rather than making extra payments toward debt.  Conversely, if you have high interest debt, such as credit card or unsecured debt, it may be beneficial to create a plan to accelerate payments to eliminate the debt. This could help fund your long-term goals such as retirement. Some debt, such as a mortgage or student loans, is hard to avoid due to the cost of a home or an education. Current mortgage rates are averaging approximately 7.5% to 8% right now for a 30-year fixed mortgage. This seems high but when you consider the average historical rate of a 30-year fixed rate mortgage being at 7.74% from Freddie Mac, it’s actually where our historical average has been. Debt to possibly avoid or eliminate in a high interest rate environment would be carrying a balance on your credit card, average credit card rates according to Forbes is 24-25%.  If you are in a position where you need to take on debt, it’s important to see what fits your circumstances, and how it impacts your future goals. In addition to the interest rate, it’s also important to consider items such as the term, the payment, and flexibility of the loan. Some questions to consider when taking on new debt in a high interest rate environment:

  • Does the payment work with my current cash flow?
    • Consider a longer/shorter term depending on your income. 
  •  Is this debt something I want to take on right now?
    • Should I borrow funds at 5-6% interest for a new car or accumulate assets monthly to purchase a vehicle in several years? 
    •  Should I buy a vacation home now, or does it make sense to rent for several years? 
  •  Can I refinance or restructure the loan in the future? 
    •  Can I refinance in the future? 
    • Can I make extra payments on the principal? 
  • It is important to discuss the advantages and disadvantages of taking on any new form of debt with your financial planner. 

If you have any questions or would like to discuss how high interest rates affect your financial plan, please contact us at 937-435-2742 to discuss with a financial planner.