With interest rates rising along with worries about an economic slowdown, now is a good time to pay down credit card balances and bolster emergency savings, financial experts say.
The Federal Reserve raised its key interest rate by an aggressive three-quarters of a percentage point in June, and it is expected to continue increasing rates until it gets inflation under control. The Fed’s goal is to cool the economy without pushing it into a recession. That’s a difficult balancing act, so it makes sense to prepare in case things go awry.
A good first step is to pay down high-interest credit card debt. Rates on credit cards are closely linked to the Fed’s moves on interest rates and are usually variable. So they are likely to rise — which means you’ll be paying more interest if you carry balances on your cards.
“It is absolutely the right time to focus on paying down those card balances,” said Greg McBride, the chief financial analyst at Bankrate. The average credit card interest rate is about 16.8% but could climb to 18% by the end of the year, McBride said.
Credit card debt fell during the first year of the pandemic but has ballooned as consumers have exhausted federal relief funds and navigated rising costs for gas, groceries and other essentials. Card balances in the first three months of this year were $71 billion higher than they were a year earlier, a “substantial” increase, the Federal Reserve Bank of New York recently reported.
Clients of American Consumer Credit Counseling in Auburndale, Massachusetts, a nonprofit agency that helps people manage debt, have reported that their expenses have gone up significantly in the past few months, the agency’s spokesperson, 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. So increasing savings to be able to cover expenses in case of a job loss or a reduction in hours should be a priority. The idea is to set aside any extra cash — even a modest amount — into an account that is readily accessible.
“Emergency savings is a key building block of overall financial security,” said Nick Maynard, a senior vice president at Commonwealth, a nonprofit focused on helping financially vulnerable people.
It may be challenging to pay down debt while also contributing to a rainy-day fund. Some employers offer programs to help workers build emergency savings, so check in with your benefits office. And a variety of mobile apps help automate deposits, making it easier for people to save at a pace appropriate for them.
Now is also a good time to renew career contacts and to sign up for training that may help expand marketable skills, should you find yourself out of work.
“This is a great time to network and polish up that résumé,” said Jen Smith, a co-host, with Jill Sirianni, of the “Frugal Friends” budgeting podcast.
Here are some questions and answers about coping with economic uncertainty:
Q: What is the best way to reduce credit card debt?
A: There are two common approaches. The first calls for identifying the card with the highest interest rate and putting extra money toward paying off that balance first. (At the same time, make the minimum payments on your other cards.) When that card is paid off, apply the extra cash to the card with the next highest rate and so on.
The second approach involves paying off the card with the smallest balance first, for a sense of quick progress, while making minimum payments on the others. When the first card is paid off, move to the next lowest balance.
If you have strong credit, consider applying for a card with a zero-percent transfer offer. You can move high-interest balances to the new account and pay them off without incurring extra interest. However, you’ll typically pay a fee of 3% to 5% of the balance you are moving, so this technique makes sense only if you can pay off the balance during the no-interest period, which often lasts 18 months.
If you need more help, nonprofit credit counselors offer debt management plans for a fee, which is offset by lower rates negotiated with card companies. The Justice Department offers a list of approved credit counseling agencies on its website.
Q: Should I reduce retirement contributions to fund emergency savings?
A: Try not to, said Michael A. Guillemette, an assistant professor at Texas Tech University’s School of Financial Planning. When inflation is high, “you have to save more” to build an adequate nest egg, he said. Contributing to your 401(k) during a market downturn may feel risky, but doing so means that you’ll be buying more shares — and that you’ll benefit when stocks rebound. And they always have, in the long run.
Q: How can I lower my expenses?
A: Target the costliest items on your budget first rather than comparatively inexpensive frills like lattes, the Frugal Friends suggest. If you rent, consider a roommate to share expenses, or negotiate with your landlord for discounted rent in exchange for handling some maintenance work. Take stock of your pantry before grocery shopping and “use the freezer more,” Sirianni said. Stockpiling extra portions and defrosting them for a quick meal can help you avoid the temptation of expensive takeout after a long workday.