Make Debt Elimination a Priority as Interest Rates Rise

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Now is the time to pay off the high-interest debt before it gets more expensive.

Variable-rate debt, like credit card balances or auto loans, is about to get more expensive because this week the Federal Reserve raised interest rates. The Fed also signaled that several more increases are coming this year, and six more are expected.

Fed rate increases do not immediately increase the interest you pay on loans, but they do affect it indirectly. Financial advisers say you should pay off your high-interest debt as soon as possible, given the Fed’s stance. It will cost you if you don’t.

Here are some tips for dealing with it.

Create a sense of urgency

You can use the prospect of further interest rate increases to create a sense of urgency to pay down your debt. Karol Ward, a psychotherapist and confidence coach in New York City, suggests visualizing what it would feel like to have to pay more and more interest. So imagine the relief of having your debt eliminated faster.

“You’ll quickly recognize, either feeling energized or discouraged, which decision is right for you,” she said.

Resolving your debts faster means you’ll likely have to reduce some extras in your life now. Although this may not be pleasant in the short term, Ms. Ward suggests focusing on the eventual gratification you will feel when you are relieved of this debt.

“Connect with pride in the efforts and actions you are taking to free yourself from this debt,” Ms Ward said.

Be motivated

Reframe paying interest on your debt as a return, which can motivate you to pay off the debt with the highest interest rate first, said Michael Liersch, head of advice and planning at Wells Fargo. Count how much money you’ll get back over the life of the debt you’re paying off, he said.

The Fed’s quarter-percentage-point hike won’t be a big deal for most credit card borrowers, said Ted Rossman, senior industry analyst at Bankrate. That will only add about $1 a month to minimum payments toward the average credit card debt of about $5,500 at the average credit card rate of about 16.34%, he said.

Yet, if you only make minimal payments, you will end up paying over $6,000 in interest and it will take you over 16 years to pay off the debt. The amount you will owe and the time it will take to pay it back will increase as the Fed raises rates.

Know your debts

Once you have your calendar, list each of your debts with its corresponding interest rate, said Manu Lakkur, product manager at Credit Karma. Creating a spreadsheet or tracking what you owe in an app can help you feel more in control, he said.

Pay particular attention to credit card debt, variable rate mortgages, home equity lines of credit, car loans and private student loans, as interest rates on these loans may rise faster than those other types of loans.

The Federal Reserve’s primary tool for managing the economy is changing the federal funds rate, which can affect not only borrowing costs for consumers, but also influence broader business decisions, such as the number of people to hire. The WSJ explains how the Fed manipulates this single rate to guide the entire economy. Illustration: Jacob Reynolds

Make a plan

Financial planners generally recommend paying off expensive debts first before tackling low-rate balances.

Interest on your debt can accrue faster than the growth you can expect from your investments over the same period, said Kyle McBrien, financial planner at Digital Investment Advisor Betterment.

Think of your minimum debt payments as fixed expenses, McBrien said. Then, be aggressive in paying off the loan with the highest interest rate first, then move on to the next to minimize the total interest paid over time.

Consider a “scorched earth” strategy of spending as little as possible and selling any assets you don’t need at the moment, such as collectibles, to help you get out of debt faster, a said Benjamin Rickey, a financial planner in Yakima, Wash. .

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“It will be painful,” Mr Rickey said.

Refinance your debt

If you have variable interest rate loans, consider refinancing to lock in a fixed rate. This will give you a reliable monthly payment that won’t increase further if interest rates continue to rise.

The decision to refinance largely depends on your financial situation and your goal, said Credit Karma’s Lakkur: to save money over the life of your loan or to be able to reduce your monthly payment to free up additional cash.

If you have significant credit card debt or are juggling multiple credit card payments, consider consolidating with a personal loan, which tends to come with lower interest rates, especially if your credit is good. .

Sign up for a 0% balance transfer credit card, said Mr. Rossman of Bankrate. You might be able to avoid interest for about 21 months and save hundreds in interest payments depending on how much you owe, he said. Most offers charge a transfer fee of 3% to 5%, but it can be worth the cost as long as you’re disciplined to return the money during the 0% offer period, Rossman said.

Write to Veronica Dagher at [email protected]

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