It might be time to prepare for higher interest rates. There are some basic things you can do to protect yourself and your family’s finances during period rising interest rates. It is incredibly difficult to predict where interest rates might go. However, when rates are at historical lows (at or near zero percent) there is only one direction possible and that is up.
Interest rates have been at historical lows for a lengthy period of time. There is no reason to think that rates will make a drastic move upwards but it is certain that they will move upward at some point. Most experts predict rates will start to climb in North American in the later parts of 2010. The exact point at which rates will rise and the magnitude of each increase is much more difficult to predict. However, one thing remains certain the next move made by the central banks will be to push rates upwards.
Interest rates are effected by the interplay of monetary policy, inflation and supply and demand. Monetary policy is the governments way of managing the economy. Inflation is the increase in cost of good over time and supply and demand is the interplay between the quantities of item X vs. the demand for item X.
There are a number of ways to prepare for a higher interest rate scenario. I will outline three ways below:
1. Consider locking in your mortgage. People with variable rate mortgages have been given the treat of a lifetime in the past few years. However, like all good things nothing can last forever. It might be a good time to speak to your banker about locking in your mortgage into a 3-5 year term. If you absolutely cannot let go of the tantalizing variable rates then consider locking in a portion of your mortgage.
2. Avoid buying longer term T-bills or GICs. The difference in rate of return between a one year instrument and a five year instrument is not worth the risk of buying long. Interest rates will go up at some point and you do not want to be locked into a 5 year GIC at a 2% return. Keep buying 6-18 month instruments so that you have flexibility to lock in at higher rates when rates begin to climb.
3. Pay down debt as quickly as possible. Low interest loans have lulled us into complacency. Rates will rise and you do not want to be stung when they do. By making extra payments on debt right now you are paying more to principle and less to interest. It makes a lot of sense to reduce the principle of your debt as quickly as possible. It is possible to do that in a low interest environment.
The three factors outlined above are certainly not the only techniques you could use. One thing is certain, rates will rise and it is important to think about how to prepare for higher interest rates.