Dubai: Interest rates were hiked in the world’s largest economy, the US, a move that was followed by the UAE central bank as well. Here’s how you can prepare your finances in order to factor this in.
Countries worldwide are looking to push past the economic effects of the pandemic and the resultant ultra-low-interest rate policies that are in place currently.
Even before the pandemic began, particularly during the past decade, interest rates have been so low it didn't matter what you did with your cash.
There was a certain convenience to that — you didn't have to move money between savings and higher-rate accounts, because they paid almost the same.
Interest rates raised in the US, UAE
However, to speed up post-pandemic economic recovery, it was announced that the top economy, the US, would raise interest rates as more countries elsewhere have already been doing so.
The central bank also penciled in a series of further increases this year to stop the economy from overheating and reducing inflation that is running at its highest levels in four decades.
The central bank of the UAE on Wednesday also hiked its base interest rate by 0.25 per cent after the US increased rates by the same margin.
Although this has historically been the trend following a period of global economic decline, what does that mean for you as a borrower? Higher interest rates make borrowing more expensive.
For households, that could mean higher mortgage costs, although - for the vast majority of homeowners – analysts opine that the impact is not immediate, and some will escape it entirely.
While rising interest rates means it costs more for you to borrow, it also can work in your favour. Here are a few examples of how interest rate hikes can benefit you financially.
Depositing more money into savings can benefit
Savings accounts have been at historically low interest rates in the past few years. While a hike in rates won't make you rich, it can give you a slight boost in your savings power, for no extra work.
As interest rates increase, now is a great time to start socking extra money away into savings accounts. However, analysts also warn that the potential benefit of a better return on savings could be muted in most cases.
So while putting extra money into savings might not result in as much interest earned from other saving avenues, such as retirement accounts or other investments, you can use the higher interest rates as an incentive to boost your savings or emergency fund contributions.
Take advantage of still low interest rates
Savers are often borrowers too, but the money in the bank has effectively been falling in value for some time. After the financial crisis of 2007, lending came to a near halt and central banks worldwide drove interest rates to the floor.
Higher interest rates may make it more expensive for borrowers than over the past several years, but rates are still near historic lows. While it's important to use caution when borrowing money, now might be the time to strike if you've been on the fence about making a big purchase, such as buying a home.
Brokers have predicted any rises in mortgage rates to be “slow and measured”, which would mean mortgages would stay cheap by historical standards for some time.
How US rate hikes bring in forex benefits for you and me
As US interest rates rise, it could very likely strengthen the US dollar. A stronger dollar means those travelling abroad can get a better exchange rate than usual. With exchange rates working in your favour, you can splurge a little bit more (or save more) than you had maybe originally budgeted for.
So an increase in US interest rates will be immediately reflected in the interest rates across the GCC countries that have their currencies pegged to the US dollar with the exception of Kuwait. In Kuwait too, the dinar is pegged to a basket of currencies dominated by dollar.
In the UAE, lending rates move in tandem with the US rates as the Central Bank of UAE (CBUAE) has historically mirrored US rates to avoid currency market volatility and speculation against the UAE dirham in the context of the UAE currency’s peg to the dollar. So expectedly, the UAE's top lender raised rates after the US did on Wednesday.
What a consumer should do when interest rates are hiked?
• Step #1: Pay off your debt now rather than later
The interest rates on your debt will rise if central banks continue to increase rates henceforth. This means you will be required to pay even more interest on your debt, owing more money overall.
You can lessen the blow by prioritising your debt repayment now. The sooner you pay off debt at a lower interest rate, the more money you will save. Use the risk of increasing rates to get your debt paid off as soon as possible.
Credit card debt is especially susceptible to climbing interest rates. Credit card debt has its own high interest rate, so any additional increase from central banks will only cost you more. Avoid paying extra interest by prioritising debt repayment today.
• Step #2: Consider refinancing your existing loans now
If you've been considering refinancing your home or auto loan, you may want to do it before central banks consider increasing rates even further. In addition, if you bought your home at a higher interest rate and have not yet considered refinancing, you may not be getting the best deal available.
Even if interest rates don't change again, you may still find it advantageous to refinance your mortgage or auto loan to a better rate.
4 reasons why keeping cash handy is vital, regardless of rate hikes
Before we take a look at where you should be holding your money when interest rates are rising, let’s first revisit a few reasons why you need cash on hand regardless of the interest rates.
There are four main reasons to hold cash: liquidity balances, planned expenses, temporary holdings, and an emergency fund. The size of your temporary holdings may vary quite a bit from time to time, but the others have pretty specific parameters that it's worth being clear about.
1. Liquid balances
Your income arrives as a lump sum on a date that doesn't match the due dates of your bills, so having liquid balances help. Having liquid balances simply means the cash you keep on hand to smooth your due payments, so that you can pay each bill when it's due and not when it’s late.
Sizing the cash demands of your liquidity balances is easy: It's the total of all the bills that might come due between income payments. Once you know this amount, you can set it aside for when you need it.
2. Planned expenses
Everybody has some expenses that are not regular monthly bills, but are nevertheless known in advance. Some of these are regular, they're just not monthly: insurance premiums, tuition payments, etc.
Others are irregular, such as discretionary payments on things like home improvements, airfare for your vacation, buying a boat, etc. Regular or irregular, if there's a near-term payment to make, it's good money management to hold some cash to pay it.
3. Temporary investments
Sometimes you have cash that you've decided to invest, but that you aren't ready to invest yet. Maybe you don't know exactly where the money should go until the next time you rebalance your investment portfolio.
Maybe you expect market conditions to improve. Maybe you're accumulating money to meet the minimum balance of some fund. Whatever the reason, until you're ready to invest, you're holding the money as cash.
Your emergency fund is cash set aside to handle a financial crisis — a job loss, a medical bill, a home repair, etc. Having the money on hand means that you won't have to turn to credit cards or other forms of debt to get through your emergency.
Experts often recommend an emergency cushion of three to six months' worth of daily living expenses. Your unique situation — such as an expensive medical condition or a high-paying job that would be difficult to replace — may call for a larger fund.
An interest rate hike would translate into higher financing costs at all levels. Individuals who have fixed rate loans will stand to benefit if their rates are locked for the entire term of the loan.
Those who have loans with flexible rates will see an immediate jump in their interest costs after the US hikes the rates. Analysts see a higher loan charge could push up mortgage, personal-loan rates and rates on funding to individuals.
Although it can make borrowing more expensive as interest rates rise - especially for homeowners with mortgages - but it can also give savers a better return.
While savers may welcome news of higher rates, analysts warn there is no guarantee the higher bank rate will lead to better returns on savings. Even if savings rates increase slightly, returns are still well below the rate of inflation.