With the prime lending rate reaching new highs, some borrowers are beginning to feel the crunch.
In July, the Federal Reserve raised interest rates by 0.75 percentage points in its latest attempt to beat inflation. July’s rise follows June’s 0.75 rise, which was the strongest rise in nearly 30 years.
In total, prime borrowing rates have climbed to 5.50% this year. Additionally, you can expect increases to continue sporadically throughout the year until the Fed gets a grip on today’s searing inflation.
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As the central bank steps up its efforts to bring inflation down to 2%, borrowers are in it for the long haul. Any adjustment to the prime rate will shake up the financial world, raising the prices of most consumer loans.
What impact will this have on the cost of borrowing? And what happens to the loans you have already taken out? If you’re worried about interest rates, keep reading to understand why these increases are happening and what you can do to manage them.
Why are interest rates rising?
The aggressive increase in the prime interest rate by the central bank is designed to rein in runaway inflation, which surpassed another record benchmark this summer. In July, the Consumer price index reached a breathtaking 9.1%, the highest in 41 years.
The theory is that Federal Reserve actions will freeze prices since people are less inclined to borrow when rates are high. This will in turn reduce people’s purchasing power and reduce expenses.
Eventually, retailers will get the hint and raise their prices at a slower rate or, ideally, lower them to encourage shoppers to return to their stores.
It may take some time for the average consumer to see these changes reflected in prices at the grocery store or at the pump. In the meantime, however, they will immediately feel the Fed’s interest rate hike.
What do these latest hikes mean for your next loan?
All that talk of prime borrowing doesn’t mean you’ll get that rate the next time you borrow, or even that your current short-term personal loans and credit cards will hit that benchmark. It simply represents the lowest possible rate available to the most creditworthy borrowers.
Each time the central bank adjusts this low rate, it has a ripple effect on most (but not all) credits that charge a higher rate. Everything is adjusted accordingly, meaning you can expect a new loan to cost around 1.5% more.
This means that a loan that would have cost you around 7% two years ago will now cost you around 8.5% after these increases.
How will higher rates affect your finances today?
Those who already have short-term personal loans and credit cards in their name want to know what they can expect from those rates. The answer depends on the terms of your credit and whether you have accepted a fixed or variable rate.
What is a fixed rate loan?
A fixed rate means that the interest rate charged to your loan will not change for the life of that loan, regardless of the actions of the Fed. You have signed a contract that obliges you and your lender to set the terms of the loan, including the interest rate.
Car loans, online installment loans, some student loans, and even some mortgages come with fixed rates.
What is a variable rate loan?
A variable rate, on the other hand, means that the interest rate charged on your loan will fluctuate with changes in market interest rates. Your variable rate loans will become more expensive as your lender adjusts their rates to reflect the latest hike.
Many credit cards and lines of credit are variable, but so are some mortgages and short-term personal loans.
If you have an outstanding variable mortgage or personal loan, your monthly payments will be slightly higher. When it comes to credit cards and lines of credit, you’ll pay more interest on any balance you carry.
What you can do to manage these price increases
If you’re struggling to make ends meet, here are some tips to help you overcome that final financial hurdle.
make a budget
A budget is a spending plan that helps you prioritize your cash flow in the most efficient way possible. It gives you an overview of your spending so you know how much money you need to make ends meet.
With your online loan payments taking up more of your monthly budget, you need to adjust your spending to make sure you have enough money to cover those bills. and your other essentials.
If you’re having trouble sticking to a traditional budget, don’t panic. There is no one-size-fits-all approach to the budget. In fact, you can experience many different types of budgets to help you cover the rising costs of your mortgage, online loans and credit cards.
Whatever you choose, you want something easy to track each month. A budget is only useful if you use it regularly.
Reduce discretionary spending
If you’re struggling to stretch your budget to cover everything, it might be time to eliminate some of your expenses. Focus on discretionary spending first, like takeout, streaming services, and subscriptions. Although they can be fun, they are not essential for survival, so you can remove them without endangering your health and safety.
Adjust your essential expenses
For most people, eating out once in a while won’t make or break their budget. The bills they pay each month, on the other hand, promise greater savings potential.
Recurring bills such as your utilities, insurance, cell phone and internet plan, groceries, and fuel costs take up a bigger chunk of your budget, due to inflation. Anything you do to control these costs will free up more money to pay off your debt.
When it comes to insurance, cell phone bills and internet, shop around. See if you can find a better plan at a lower rate from another company. Call your current suppliers before you jump ship to see if they’re willing to cut your costs to keep you as a customer.
When it comes to grocery and fuel costs, you’ll need to be crafty to keep those bills down. Try walking, biking, or carpooling more often, and research where the cheapest gas stations are in town. Learn the art of cooking meals around promotions and coupons to fill your belly with cheap yet nutritious food.
Start saving more
On a more positive note, this hike doesn’t just affect the cost of borrowing â it also increases the amount you earn on savings. Take advantage of higher savings rates to earn more on the money you set aside for emergencies.
Now is the time to build an emergency fund, so be sure to use your budget to free up some money for this goal. A generous emergency fund can help you avoid borrowing at higher costs, since you can rely on those savings to meet unexpected expenses and bills.
In summary: your budget must change
Although you can’t do anything to change inflation or prime borrowing rates, you can control your budget to resist these economic forces. Reduce your monthly expenses if you repay variable loans. Anything you do to reduce overspending can help you cope with higher interest rates until the economy balances out.
But it’s a good idea to check your budget even if you’re lucky enough to have fixed terms. Your budget can help you save more, so you don’t have to borrow at higher rates.