Credit Basics
How To Stay Ahead Of Rising Interest Rates
Friday, October 01, 2004
Jean Chatzky
Consumer Reports
MORTGAGES
If you're buying a home, it still makes sense to go with a fixed-rate mortgage even though rates have gone up, says Greg McBride, senior analyst with Bankrate.com, an aggregator of financial-product information. But fixed doesn't have to mean locking in for 30 years. If, like the majority of homeowners, you move every seven years or so, McBride recommends hybrid mortgages, which have fixed rates for the first several years (commonly 3, 5, 7, or 10), then convert to a variable rate. Rates on hybrids are 1 percent or more below the rates on 30-year loans.
If you already have a one-year adjustable-rate mortgage, consider refinancing at a fixed rate. "You want to avoid a rate adjustment in the next two or three years because those adjustments are likely to be fairly significant," McBride says. (For some examples of how high monthly payments can go if interest rates climb just a few percentage points in the next year or two--which is a reasonable assumption based on past trends--see the table below.)
Riskiest of all are interest-only ARMs, which are common in southern California and other areas where property prices have soared in recent years. "Lots of people bought more house than they could afford because they could swing monthly payments on interest-only adjustable-rate loans," says Howard Dvorkin, founder of Consolidated Credit, a credit-counseling agency. "If the Fed increases rates even incrementally, that monthly payment could double within three or four years and mortgage holders won't have any equity in the house."
If you have such a mortgage and can afford to switch to a fixed rate or hybrid--fees are typically 2 percent of your mortgage amount--consider doing it now.
HOME-EQUITY CREDIT
Home-equity lines generally have variable rates. You can switch to a fixed rate with a home-equity loan, but the rate gap between the two is big--in July 2003 fixed-rate loans were 2.25 percentage points higher than rates on home-equity lines.
"If you're borrowing a significant amount--say, $50,000 or more--for more than three years, you'd be better off locking in a fixed-rate home-equity loan," McBride says. For a smaller loan that you plan to repay in a few years, the credit line would be a better choice.
CREDIT CARDS
Whether you have fixed- or variable-rate credit cards, expect your rates to rise, warns Robert Manning, author of "Credit Card Nation." Minimize finance costs by making a list of all your cards and their rates and consolidating debt at the lowest rate. Just be sure not to put too much debt on one card. Carrying a balance that is 70 percent or more of your available credit can hurt your credit score. Shifting card debt to a low-rate home-equity line can be a smart option, but only if you're committed to paying off the debt and to avoiding getting in over your head again.
