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November 9th, 2022

Impact of Higher Interest Rates for Borrowers and Savers

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Sarah F. from Brockton, MA asks: Good morning, Mitch. With all of the interest rate increases going on, is now the time to be making some changes as it relates to savings accounts and other aspects of my financial plan? I just want to make sure I’m not missing something. Thank you.

Mitch’s Response:

Thanks for your great question. There are indeed implications to higher rates for most people, but those implications are quite different depending on if you’re a saver or a borrower.

Let me start with the borrowers. In the credit card realm, the average annual percentage rate (APR) on a credit card before the pandemic was 17.35%, and now that figure is close to 19% – a 30-year high. Meanwhile, credit card balances are up over 20% from lows reached last April, which signals that people are spending more on credit at just the wrong time. Americans are missing fewer payments today than they were pre-pandemic, which is good, but the trend of rising balances and higher rates overall is worrisome.1

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So, my first piece of advice in this rising rate environment is to make sure you wipe out any credit card balances that may be collecting interest. Making sure you do this is of greater urgency than any savings plans, in my view.

Next on the list for borrowers is the mortgage market, which has seen the 30-year fixed rate jump from 3% a year ago to now over 7%. 30-year fixed mortgage rates haven’t been this high in 20+ years, and the rapid uptick has changed the dynamics in the housing markets. As far as your financial plan is concerned, if you were thinking of moving or buying a new home, you may want to consider what the higher interest rate does to your monthly mortgage payment. The same goes for refinancing or trying to withdraw equity for a remodeling project or other expenses – now may not be the right time for either.

As for savers, the risk-free interest rates you can earn on savings have also improved and may continue improving, but it’s also true these rates are coming off the zero bound. Interest on savings accounts at banks, for instance, have moved from 0-0.5% to slightly north of 2%, which few people would consider an attractive rate of return – particularly with current levels of inflation. Banks do not necessarily need to compete for deposits, since many are flush with capital, which means that interest rates on savings accounts are not likely to move up substantially in the near term. Savers can shop around for the highest rates.

There are other risk-free methods of savings, though the options are less liquid than in savings accounts. I’ve seen Certificates of Deposit (CDs) in the 6–12-month range paying north of 3%, and in the U.S. Treasury bond market investors can currently earn a higher return on the 1-year U.S. Treasury bond than the 30-year U.S. Treasury bond, due to the inverted yield curve. Yields on the very short end of the curve are also quite attractive, in the 4% range. For risk-free securities, these are good returns, especially considering how low these yields have been for the last couple of decades.

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Disclosure

1 Wall Street Journal. November 2, 2022. https://www.wsj.com/articles/what-the-feds-rate-increases-mean-for-your-financial-plans-11667347555?mod=djem10point

2 ZIM may amend or rescind the free guide offer, Using Market Volatility to Your Advantage, for any reason and at ZIM’s discretion

3 ZIM may amend or rescind the free guide offer, Using Market Volatility to Your Advantage, for any reason and at ZIM’s discretion


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