Interest Rates Will Be Higher for Longer Loan. Strategies in a High-Rate 2023By: David Halverson April 24, 2023
In what seems like a long time ago, Federal Reserve chairman Jerome Powell stated in 2022 that the spike in the inflation rate was likely to be “transitory.” Unfortunately, after hitting the highest levels in over 40 years in mid-2022, inflation has persisted into 2023. To combat these rising costs, the Fed has embarked on an aggressive campaign of raising interest rates. While some predicted those increases would stop early in 2023, they seem likely to continue at least until the summer, with the fed funds rate topping 5% and perhaps hitting 5.5% or more. Those rate increases in turn have pushed up consumer rates across the board, increasing the cost of everything from personal loans and home mortgages to auto rates and more. In this type of environment, where interest rates are high and seem likely to stay that way for the near future, what type of loan strategies should consumers employ? Here are a few suggestions.
Do the Math
The most important thing that you can do when planning your loan repayment strategy is to calculate your actual costs. For example, if you took out a 4-year, $5,000 loan two years ago, you might have snagged a 5% interest rate. That would put your monthly payments at $115. In today’s market, you might have to pay 10% or more for that same loan. That would bump up your payments to $127 per month. That might not seem like too big of an increase, but what it translates to is you paying nearly $1,100 in interest over those four years instead of just $527.03 with the 5% rate. That seemingly small increase in your monthly payment actually more than doubles your interest cost.
Now, in some cases, you may still deem that the higher rate is worthwhile. This is particularly true if you are paying off higher-rate debt, such as with a credit card. Just like personal loan rates have trended up, so too have credit card interest rates, to the point that many now charge over 20% annually. Do the math and see what makes the most sense for you.
Check Your Cash Reserves
If you have ample cash reserves, you might consider avoiding taking out a loan altogether and just spending down some of your bank account. While you shouldn’t dip too deeply into your emergency fund or other money you have reserved for long-term goals, if you’re in a financial pinch and have the cash, it can be prudent to avoid taking on more debt.
Review Your Budget
If you’re considering taking out a loan, reviewing your budget will provide you with two benefits. First, you can ensure that if you do take on any new debt that you have room in your budget to make those payments. Second, it may provide you with an opportunity to avoid taking out a new loan by freeing up some space in your budget. For example, if you’re saving $300 per month for your vacation fund, it may make sense to use that cash instead to pay off high-rate debt or to cover your expenses. Although no one likes postponing a vacation, if your travel costs are keeping you in a financial hole, diverging that money – even temporarily – might be the difficult but appropriate step you should be taking.
Find the Lowest-Cost Loan
If you’re set on taking out a new loan, it’s imperative in a high-rate environment to find the lowest-cost loan possible. While you should always shop around for the best loan, when rates are high, that’s the time it’s absolutely essential to cut your costs. In addition to searching for the lender with the lowest rates, make sure you don’t overlook any fees, such as origination fees or prepayment fees.
Consider a 0% Credit Card
Since loan interest rates are currently quite high – and potentially going even higher – it may make more sense than ever to consider a 0% balance transfer credit card. Many of these types of cards allow you to make deposits directly into your checking account, effectively acting as a direct loan. However, there are a number of things you’ll have to factor in if you’re going this route.
The most important is that the 0% rate that some cards offer is a promotional rate, and it expires after a relatively short period of time – typically, from 12-20 months. If you won’t be able to pay off your debt after this time, you might want to consider a more traditional loan, as your credit card rate will likely skyrocket to 20% or more.
The next thing to be aware of is that most 0% credit cards charge a fee to access that money, typically between 3% and 5%. Generally speaking, this is likely to be lower than the rate you’d get on a traditional loan, but it’s something to bear in mind when doing the math.
One other factor to consider is if you’ll be getting any perks or bonuses from opening a 0% credit card. In addition to the low initial rate, you might be able to score travel benefits, like airport lounge access or free luggage, or hotel perks, like free rooms. If you’re going to benefit from these additional features, they should be part of the calculus when you’re determining what type of financing to use.
The Bottom Line
Trying to figure out the right type of financing in a high-rate environment can be difficult. With many loan rates in the double digits, it may be a good time to hold off on taking out new loans unless absolutely necessary. But if you really need some extra funds, shop around for the best deal you can get and be sure that you can refinance your loans if rates fall – as they may very well in 2024 and beyond. Talking with a personal loan consultant can help you make sure that you’re paired with the best possible solution for your specific financial situation.