With interest rates rising and concerns about an economic slowdown, now is a good time to pay off credit card balances and boost emergency savings, say financial experts.
The US Federal Reserve raised interest rates by an aggressive three-quarters of a point in June and is expected to continue raising rates until inflation is brought under control. The Fed’s goal is to cool the economy without pushing it into recession. It’s a difficult balancing act, so it makes sense to prepare in case something goes wrong.
A good first step is paying off high-interest credit card debt. Credit card interest rates are closely linked to Fed interest rate movements and are typically variable. So they’re likely to go up – which means you’ll pay more interest if you have balances on your cards.
“It’s absolutely the right time to focus on repaying those card balances,” said Greg McBride, Bankrate’s chief financial analyst. The average interest rate on credit cards is about 16.8 percent but could rise to 18 percent by the end of the year, Mr McBride said.
Credit card debt fell in the first year of the pandemic but has skyrocketed as consumers scooped up federal aid money and coped with the rising costs of gas, groceries and other essentials. Card balances for the first three months of this year were $71 billion higher than a year earlier, a “substantial” increase, the Federal Reserve Bank of New York recently reported.
Frequently asked questions about inflation
Frequently asked questions about inflation
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar won’t go as far tomorrow as it did today. It is usually expressed as the annual change in the price of essential goods and services such as food, furniture, clothing, transportation and toys.
Clients of American Consumer Credit Counseling in Auburndale, Mass., a nonprofit agency that helps people manage debt, have reported that their spending has increased significantly in recent months, agency spokeswoman Madison Block said.
“It’s harder to stick to a budget,” she said.
A slowing economy may mean that some companies will start laying off workers. Therefore, increasing savings to cover expenses in the event of a job loss or reduction in hours should be a priority. The idea is to put extra money – even a modest amount – in an easily accessible account.
“Emergency saving is an important building block of overall financial security,” said Nick Maynard, senior vice president at Commonwealth, a nonprofit focused on helping people who are financially vulnerable.
Paying off debt while contributing to a rainy day fund can be a challenge. Some employers offer programs to help employees build emergency savings. Therefore, contact your benefits office. And a variety of mobile apps help automate deposits, making it easier for people to save at a pace that suits them.
Now is also a good time to renew professional contacts and enroll in training that can help develop marketable skills if you find yourself unemployed.
“This is a great time to network and brush up on your resume,” said Jen Smith, co-host with Jill Sirianni of budgeting podcast Frugal Friends.
Here are some questions and answers about dealing with economic uncertainty:
What’s the best way to reduce credit card debt?
There are two common approaches. The first involves identifying the card with the highest interest rate and investing additional money to pay off that balance first. (Make minimum payments on your other cards at the same time.) When that card is paid off, apply the extra cash to the card with the next higher rate, and so on.
The second approach is to pay off the card with the smallest balance first to get a sense of rapid progress while making minimal payments on the others. When the first card is paid off, switch to the next lower balance.
Understand inflation and how it affects you
If you have a strong credit rating, consider applying for a card with a zero percent transfer offer. You can transfer high-interest deposits to the new account and pay them off without interest. However, you typically pay a fee of 3 to 5 percent of the balance moved, so this technique only makes sense if you can repay the balance during the interest-free period, which often lasts 18 months.
If you need more help, nonprofit credit counselors offer debt management plans for a fee, offset by lower rates negotiated with card companies. The Department of Justice provides a list of approved credit counseling agencies on its website.
Should I reduce pension contributions to fund emergency savings?
Don’t try, said Michael A. Guillemette, an assistant professor in Texas Tech University’s School of Financial Planning. When inflation is high, “you have to save more” to build up a decent nest egg, he said. Contributing to your 401(k) during a market downturn may feel risky, but it means you buy more stocks — and benefit when stocks rally. And they always have in the long run.
How can I reduce my expenses?
Aim for the most expensive items in your budget first, rather than comparatively inexpensive frills like lattes, the Frugal Friends suggest. If you’re renting, consider a roommate to share the costs, or negotiate a reduced rent with your landlord in exchange for some maintenance. Before you go grocery shopping, take stock of your pantry and “use the freezer more,” Ms Sirianni said. By keeping extra portions on hand and defrosting them for a quick meal, you can resist the temptation of an expensive grab-and-go meal after a long day at work.