Inflation is coming: There's still time to act

By Don Kuehn

Since April, the financial markets have been gyrating--up one day, down the next—as everyone tries to factor in the effects that higher interest rates will have on the economy. The Federal Reserve Board, which controls rates, acted this summer to boost rates by half a point.

Given Fed chairman Alan Greenspan's cryptic style, it's difficult to decipher exactly how high rates will go. But just as they took a long time to ratchet down, they are likely to continue moving up in small increments. So there's time to avoid the worst effects of creeping inflation.

Higher rates are a two-edged sword. Increased return on savings rates will help seniors and others dependent on income from certificates of deposit (CDs) or money market accounts. On the other hand, rising rates equate to higher costs for consumer goods and services.

When do you begin preparing for the changes that will come with rate increases? Like most decisions affecting your money, the sooner the better. Rising interest rates will increase the cost of paying off many kinds of loans, including home equity loans, credit card debt and anything else tied to bank prime rates.

• It costs average families $39,500 a year to keep a roof over their heads, food on the table and household maintenance, according to the Bureau of Labor Statistics. That's almost 17 percent more than they shelled out in 1996, even though "official" inflation has been almost nonexistent in the past eight years.

• Typical families don't normally buy the same goods and services that the government uses to clock inflation rates. So, modest cost-of-living increases to Social Security, defined benefit pensions and some salary increases triggered by the U.S. Consumer Price Index pale in comparison to the reality of higher costs at the gas pump, in the grocery store and at the pharmacy.

The cost-of-living adjustment for Social Security recipients last January, for example, was a meager 2.1 percent. That was far smaller than the increase most retirees saw in their Medicare supplemental insurance alone. As my Dad used to say, "I can't win for losing."

• There are two starting points to prepare for the days of higher prices: Cut spending or increase earnings. Cutting spending may require sacrifices in your everyday life: canceling that cell phone or cable service, eliminating meals away from home, dropping a bad habit (like smoking) or paying down credit card debt.

Increasing earnings may mean you or your partner may have to find a part-time job or do more overtime, if possible. At least set aside any salary increment you are due to receive this year and continue to budget based on last year's earnings. Caution: Every payday, take the difference and "pay yourself first" in a savings account, lest the increase slip away unnoticed.

• During the mortgage rate downdraft of the past few years, many AFT members refinanced high-rate loans and saved thousands of dollars a year on their house payments. However, some took the option of even cheaper adjustable rate mortgages (ARMs) or even new "interest-only" loans. If you plan to stay in your house long enough to recoup the costs of refinancing, now is the time to look seriously at locking in the best fixed-rate mortgage you can find before rates go up.

• Home equity loans and lines of credit also will cost more as the Fed continues to act. Unlike ARMs, home equity loans typically are not capped or limited in how much they can rise in any given year. They could become very costly if rates jump quickly.

• The bane of most consumers trying to get their heads above water is the amount of credit card debt they carry. About 40 percent of the cards in use are variable-rate cards. Many of these are tied to the Fed's prime lending rate and will rise at least as fast as the prime. If your cards are fixed-rate, you shouldn't relax, either. The banks that issue those cards are free to change the terms of the contract with as little as 15 days' notice. The surest way to beat the card companies at their own game is to pay them off without interest. If you wait until rates go up, it will be harder than ever to get out from under that debt load.

Here are a few simple tips to help you as prices rise due to higher interest rates:

• Track your expenses. That means knowing where every dollar goes to see where your budget has leaks. Keep a small journal, like a day planner, to note every cost you incur. Things like coffee at Starbucks, unexpected lunch with your co-workers or a wedding or baby gift that wasn't planned for can add up.

• Cell phone or cable services that you don't use much should be cancelled. Premium channels, features on your phone and other bells and whistles cost you unproductive dollars every month. Stop them.

• Set up a budget. If you are unaccustomed to budgeting, get used to it. Most people in financial crisis have one thing in common: They don't have a household budget to guide their spending and saving, one that starts with a deposit every month into a savings or investment account.

• Something those credit card companies know that most of us don't is that very few people actually use the "bonuses" that come from points earned on their cards. You pay an annual fee to get a card tied to airline (or other) points and never seem to reach the threshold needed to cash in. Consider canceling that point-based card and getting one with no annual fee. If you're not working the system anyway, you can save the fee and not be tempted to overuse your credit card in a meaningless effort to rack up points.

• Shop wisely. Buy store brands and generics, don't buy what you don't need and don't use credit unless absolutely necessary. Save real cash money to buy important items. And delaying a purchase often gives you time to assess whether you really need the item.

• Keep your car properly maintained and the tires inflated to the manufacturer's recommendations. Even with gas prices easing a bit, small steps will improve your gas mileage.

• Be cautious about rolling credit card debt into a refinancing of your mortgage. Too much debt added to the mortgage will reduce your equity and make your payments higher. It might be better to keep the two separate and use the extra cash to pay off the debt directly.

• With higher interest rates on the horizon, avoid tying up your savings in long-term CDs. Since you can bet on higher rates in the future, don't buy a CD with a term of more than 12 months.

For almost a decade, inflation has stayed in check and interest rates have fallen to record low levels. The Federal Reserve manipulates rates to accomplish economic goals. At times, the Fed "tightens" monetary policy and rates go up. When it's necessary to spur the economy, the Fed may "loosen" or cut rates, as it has over the past few years. We are at a point when the pendulum is going to swing in favor of higher rates. It makes sense to prepare for that by taking a few fairly painless steps now. Waiting will cost you.