The Fed may need to fight inflation with a quicker rate hike cycle. Here’s how you can prepare

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For most Americans, the surging cost of living is weighing heavily on their wallets.

“Wage growth has failed to match the dizzying pace of rising prices, which the Federal Reserve has effectively identified as ‘monetary policy enemy No. 1,'” said Mark Hamrick, senior economic analyst at Bankrate.com.

After the Fed raised interest rates for the first time in more than three years, Chairman Jerome Powell vowed tough action on inflation, which he said jeopardizes an otherwise strong economic recovery.

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Now the expectation is that the central bank may raise rates by a half percentage point at each of its May and June meetings.

Each move will correspond with a hike in the prime rate and immediately send financing costs higher for many forms of consumer borrowing.

What to know about rising interest rates

Consumers will see their short-term borrowing rates, particularly on credit cards, among the first to jump.

Since most credit cards have a variable rate, there’s a direct connection to the Fed’s benchmark, so your APR will increase with each move by the Fed, usually within a billing cycle or two. 

Adjustable-rate mortgages and home equity lines of credit are also pegged to the prime rate. Most ARMs adjust once a year, but a HELOC adjusts right away. 

Because 15-year and 30-year mortgage rates are fixed and tied to Treasury yields and the economy, homeowners won’t be impacted immediately by a rate hike. However, anyone shopping for a new house is going to pay more for their next home loan (the same goes for car buyers and student loan borrowers).

“Mortgage rates have been rising steadily for a month, driven higher by inflation and the Federal Reserve’s effort to control inflation,” said Holden Lewis, home and mortgage expert at NerdWallet.

“Just a couple of months ago, most forecasters were predicting that rates would rise all year but wouldn’t reach 5%,” he added. “Well, we’re approaching 5% just a quarter of the way through the year.

“Rates will keep rising until investors see inflation heading downward.”

Here are three ways to keep ahead of rising rates.

1. Pay down debt

As rates rise, the best thing you can do is pay down debt before larger interest payments drag you down.

When you look across the debts that you owe, to the extent that you can, pay down the higher interest rate debt first, said Christopher Jones, the chief investment officer at Edelman Financial Engines — and “credit cards tends to be by far the highest.”

In fact, credit card rates are currently around 16%, significantly higher than nearly every other consumer loan.

If you’re carrying a balance, try calling your card issuer to ask for a lower rate, switch to a zero-interest balance transfer credit card or consolidate and pay off high-interest credit cards with a low-interest home equity loan or personal loan.

“Even if you have to borrow a bit from your home equity loan, you would at least be paying a lower interest rate,” Jones said.

2. Put off large purchases

“One of the questions people should be asking themselves is ‘is this the right time to be making a big purchase?'” said Jones. “It’s going to cost more to buy the thing and cost more to finance.”

For big-ticket items, like a home or a car, “it may make sense to defer,” he said.

Although mortgage rates are rising, the cost of buying a home is rising even more — as home price appreciation more than doubled last year.

The same is true for car shopping. New and used car prices continue to rise amid strong demand and tight inventory and show no signs of slowing down soon anytime soon.

3. Boost your credit score

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As a general rule, the higher your credit score, the better off you are.

Borrowers with good or excellent credit (generally anything above 700 or 760, respectively) will qualify for lower rates and that will go a long way as the cost of financing creeps up.

For example, shaving a one percent off a new auto loan can save up to $50 a month, according to Francis Creighton, president and CEO of the Consumer Data Industry Association.

On a 30-year mortgage, even snagging a slightly better rate can mean monthly savings in the hundreds.

“For someone who is trying to make ends meet, that’s real money,” Creighton said.

The best way to increase your credit score comes down to paying your bills on time or reducing your credit-card balance, but there are even simple fixes that can have an immediate impact, such as checking your credit report for errors, Creighton advised.

You want to be going into the inflationary period in the strongest position you can be in.

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