Alan Greenspan, the chairman of the Federal Reserve Board, wants to squeeze your budget until it hurts.
To keep inflation from soaring, Greenspan has cranked lending rates up to their highest levels since 1984. And he doesn't plan to lighten up anytime soon in his avowed quest to reduce inflation to "approximately zero" within "several years."
Unless you are blessed only with debts carrying low, unalterable rates, your overriding concern for now should be to pay off as much principal as possible.
Credit-card loans should be your first priority. Then focus on paying back home-equity lines of credit.
Homeowners stuck with a mortgage carrying a rate higher than 11.5 percent may benefit from refinancing with an adjustable-rate mortgage at 9 percent.
Other steps you take to bolster your balance sheet will depend on the types of loans you have now or would like to take out. Here are strategies to consider:
Credit Cards -- Pay off credit card balances. When interest rates fell a few years ago, most credit-card issuers kept their charges high. That makes it all the more galling that these rates, already averaging an astronomical 18.1 percent, are becoming even steeper.
Up to a quarter of all cards adjust their rates at least four times a year, usually adding 6 to 9 percentage points to the current prime. So by summer, you may be paying 3 percentage points more on your balance than you did a year ago, even if you haven't charged anything more since then.
And at a rate of 21 percent, it will take you four months longer to pay off a $3,000 outstanding balance by paying only the minimum each month.
Home-Equity Loans -- Anyone who tapped a home-equity line of credit in the past 12 months felt the most immediate jolt from the surge in interest rates. Almost all of the $110 billion in outstanding home-equity loans is indexed to the prime lending rate, with an addition of 2 percentage points. So every time banks raised the prime half a point, home-equity borrowers owed more, usually within a pay off credit card, equity loans
month or two.
On a $50,000 home-equity loan, the 3 percentage point increase to 13.5 percent would increase your monthly payments from $457 to $573, or an extra $1,392 for the year. That's a 25 percent hike.
As a result, says William Schumann, president of Insured Credit Services in Chicago: "We are expecting rising delinquencies and defaults on home-equity loans by summer, with the potential for severe problems if rates go up another two points."
If higher home-equity outlays are busting your budget, ask your lender to switch you temporarily to an interest-only payment plan. That will reduce your monthly payments and make them fully tax deductible (on loans of up to $100,000). Of course, it will also take you longer, and cost you more, to repay your loan.
All home-equity deals have interest-rate ceilings of around 18 percent or so for the life of the loan but no annual caps. That's beginning to change, however. You may have to pay another half-point or so for such a cap, but the benefit justifies the cost during a period such as now.
Also be sure to shop for the lowest closing costs: They can range from $100 to $1,000.
Mortgages -- If you have an adjustable-rate mortgage (ARM), your interest rate will probably increase 2 percentage points in 1989. That boost should not badly sting anyone who took out a mortgage last year, when first-year rates were as low as 7.5 percent, since a 9.5 percent rate is dirt cheap these days.
On the other hand, if your ARM began two years ago at 7.5 percent, two consecutive years of 2 percentage point increases would leave you at 11.5 percent -- a jarring boost.
If you are among the unfortunate homeowners stuck with an old ARM at 11.5 percent or more, it may be worthwhile to refinance with a new ARM at a low teaser rate.
Suppose the rate on your current $100,000 ARM hits 12 percent. If you refinance now to a 9 percent teaser rate, you will save $2,688 in mortgage payments the first year. And even if your new ARM hops to 11 percent next year, you'll save another $924 in '91 -- a $3,612 savings that in most cases should more than cover your refinancing costs.
Regardless of whether you want to refinance or buy a new house, it's especially critical now to shop for a mortgage that will shield you from future interest-rate shock. Conventional fixed-rate mortgages at a steep 11.2 percent are unappealing, particularly if you believe the consensus forecast that rates will fall again by year-end.
As interest rates ratchet up, the best deals of all may be available from home sellers rather than banks, savings and loan associations or mortgage companies.
Bob Hutchinson of Century 21 of New England says that fully 25 percent of the 2,200 people who bought homes through his company the first two months of this year did so without a professional lender. That is up from 13 percent a year ago.
"When rates go up," says Hutchinson, "sellers get so anxious about finding a buyer that they'll offer very appealing mortgages of their own." You can find sellers willing to offer financing by checking with a real estate broker.
Copyright 1989 Money Magazine