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Consumers can fend off effects of rising interest rates

Updated:
Craig and Barbara Gilliland have their sights set on a new home. In fact, they're living in it and renting it from their friends while they shop for a home loan.

It isn't easy these days since the Federal Reserve recently imposed its sixth interest-rate increase in 11 months in an effort to cool down the overheated U.S. economy.

"I've been trying to lock in [a mortgage rate] for a long time because I've been watching it and it's been going up, but you can't lock in for more than 30 days," said Mr. Gilliland, a Dallas landscaper.

When the Fed raised the federal funds rate from 6 percent to 6.5 percent, it pushed that key short-term interest rate to its highest level since January 1991.

While the Fed doesn't directly control mortgage rates or other consumer interest rates, its actions send ripples through the credit industry, pushing up the price of borrowing on everything from houses to cars to credit cards.

But consumers don't have to sit passively and watch higher rates eat away at their money.

There are some things they can do to cushion the blow - and perhaps even profit. First, if you have credit card debt, pay off those cards as quickly as possible because card rates are going up.

American credit card holders on average will shell out an extra $38 in interest charges over the next year as a result of the Fed's rate increase, according to CardTrak, a Web site that follows the credit card industry.

In total, Americans will see interest charges on cards soar by $1.4 billion during the next year, CardTrak said.

Although most credit cards carry variable interest rates, "try to seek out fixed-rate cards," said Robert McKinley, chief executive of CardWeb.com, an affiliate of CardTrak.

"With a fixed-rate card, they can change the rate, but they have to send out new card holder agreements," he said. "It slows things down."

In fact, the lag time could be as long as six months to a year before a fixed-rate card issuer changes the rate, "so you're buying a little bit of extra time," Mr. McKinley said.

Also, pay your credit card bills on time and don't go over your credit limit because you pay dearly.

"Some of the punitive rates have now exceeded 30 percent," Mr. McKinley said. "Some of them will actually raise your interest rate if you habitually pay late or go over your credit limit."

That painfully high rate is in addition to the other interest and fees you're already paying.

"The message is, don't play games with your credit card," Mr. McKinley said. "When you get your bill, take care of it then. At least get the minimum payment in as soon as it comes in."

But paying as much over the minimum payment as you can afford will help you pay off your debt more quickly.

Meanwhile, cut down your use of credit cards as much as possible.

If your card issuer offers you the free ability to pay your bill electronically, sign up. It will keep you current on your bills.

You can also take advantage of card issuers' low rates on balance transfers.

"Get one of these cards with good balance transfers and just use that to transfer your existing balance and have a different low-rate card that would be used for new purchases," said Greg McBride, financial analyst at bankrate.com, which tracks consumer rates.

The Fed's rate increases have helped push many indecisive home buyers into deciding on a rate, said Craig Jarrell, president of the Dallas Association of Mortgage Brokers.

"Our phones have gone nuts ever since they've hiked the rates," he said.

"It has definitely gotten people off the fence," he said.

"It's got them worrying that rates will go even higher."

Right now, a mortgage interest rate under 10 percent is a "good interest rate," Mr. Jarrell said.

As of May 24, the average interest rate on a 30-year fixed-rate mortgage in the Dallas metropolitan area was 8.64 percent, up from 7.11 percent in May 1999, according to bankrate.com.

Keith Gumbinger, an analyst at HSH Associates in Butler, N.J., which publishes mortgage information, cautions consumers against locking in at a high fixed rate because rates will eventually fall.

"Now is not the time to be locking up long-term fixed-rate mortgage money," he said. "Interest rates are high now, but the likelihood is that at some period down the road, lower interest rates will set in."




Think adjustable rates



Instead, consider adjustable rate mortgages or ARMs, specifically what's called a "5/1 hybrid ARM," Mr. Gumbinger said.

In a 5/1 ARM, you have a fixed rate for five years and then the rate adjusts once each year thereafter.

"You'll get a fixed interest rate for the next five years that's roughly one-half percent below the comparable 30-year fixed rate," Mr. Gumbinger said.

Mr. Gilliland, the home-hunting Dallas landscaper, is considering going with an ARM.

"I'm looking at going to an ARM where I can get a good, cheaper interest rate for a period of time and refinance later when rates go back down," he said. "I'm leaning more toward a seven-year ARM, where my rate is below 8 percent now."

If you're looking for a car loan or home equity loan, those rates will rise in the next six to eight weeks, Mr. McBride said.

"The silver lining is that there is not a one-to-one movement between Fed rate hikes and auto and home equity loans," he said. "There is a lot of competition in auto loans."

For his part, Mr. Gilliland said he doesn't understand the rationale behind slowing the economy's motor.

"I'm having a hard time figuring out how come a strong economy is bad," Mr. Gilliland said.

"It's not good for me for it to slow down," he said, "because it's going to cost everybody money."




Higher returns for savers

Not everybody. While borrowers are hurting, higher rates mean higher returns for savers.

Seven-day compound yields on money market mutual funds averaged 5.85 percent as of May 23, compared with 4.36 percent in May 1999, according to iMoneyNet, which tracks money fund data. Compound yields assume reinvestment of dividends.

Money fund experts expect compound yields to break through the 6 percent barrier in a few weeks.

As for investors, the rate increase packs with it a valuable lesson about the importance of having a diversified investment portfolio, financial planners said.

"This is where having that well-diversified portfolio really makes a difference," said Bryan Lee, a Certified Financial Planner at Strategic Financial Planning in Garland.

He has a client who had 70 percent of her portfolio invested in tech stocks.

They reduced that allocation and moved some to international stocks and a diversified mix of small-capitalization and large-capitalization stocks.

If they hadn't done that, his client's portfolio would have lost more than 25 percent of its value in the market's downturn, Mr. Lee said.

"This is all the money she has," he said.



Pamela Yip covers personal finance for The Dallas Morning News. If you have a story idea, e-mail her at pyip@dallasnews.com.


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