Interest Rate Tips for 2015

The past six years have been a great time to borrow and buy, with interest rates at historic lows. But as the U.S. economy continues its recovery, many experts believe the long decline in rates will finally reverse. The key question is how soon–and at what pace.

The current wisdom on Wall Street holds that the 10-year Treasury bond, currently yielding around 2%, will end the year at about 3% and push past 4% in 2016. Short-term and mortgage rates are also expected to rise. The rationale is that the U.S. is on the mend, with the economy expected to grow at about 3% and job creation at its fastest pace since 1999. And the Fed has signaled a midyear rate boost, which would be its first in nearly a decade.

Rates are famously difficult to predict, and not all experts are in alignment. One prominent bond investor, Jeffrey Gundlach at DoubleLine Capital, believes that the T-bond yield will keep falling, down to about 1% if oil prices slip further. But most economists predict that yields will begin to tick up in the second half of 2015, which would have broad implications for the way you borrow, save and invest. Here’s what you need to know:

Borrowers: Shop now, buy later

One thing seems certain: credit is likely to get more costly. The Fed seems determined to boost the target for its benchmark federal-funds rate to a high of 0.5% from 0.25%. A second bump could follow. Typically, long-term rates set in the bond market follow suit.

By year’s end, interest rates on credit cards will creep from 15.7% to 16.2% on average, says Bankrate.com. Five-year new auto loans will rise to an average of 4.4% from 4.1%, and fixed 30-year-mortgage rates may near 5%, up from around 4%. The good news is that the rise in these borrowing costs will be slow and manageable.

“There is no rush to borrow,” says Mark Zandi, chief economist at Moody’s Analytics. But if a large purchase is in your near future, shop now so you’ll be ready when rates move up. That’s especially important with a mortgage, for which the approval process can drag.

Savers: Some relief ahead

As the Fed boosts short-term rates, you’ll earn more money from bank CDs and money-market accounts. But it may be a couple of years before rates are high enough for savers to earn anything meaningful. “It’s going to be another tough year for savers,” says Greg McBride, chief financial analyst at Bankrate.com. “But at least rates will be taking a step in the right direction.”

For now, he suggests keeping liquid savings in short-term accounts that can be rolled into higher-yielding vehicles as rates rise. He advises creating a ladder of bank CDs that mature in six months, a year, 18 months and two years, rolling over into higher-yielding CDs as they expire. Don’t be tempted to reach for modestly higher yields on CDs that mature in three years or longer. That would prevent you from taking advantage of the higher yields that should emerge in the next two years.

Investors: Shake it up

The big risk for bond investors is that interest rates will rise more sharply than expected. Watch the central banks in Europe for clues: if they begin to raise rates, it could trigger a global rise in long-term rates.

In any rising-rate environment, the key is to own bonds that can be held to maturity, allowing the owner to reinvest at higher yields. “Stay with high-quality bonds, and reduce your average maturity to five to seven years,” says Kathy Jones, fixed-income strategist at Schwab Center for Financial Research. Yields on riskier credit like corporate junk bonds will rise fastest and lead to the biggest losses, she says.

Diversification across the fixed-income universe, including Treasurys, mortgages, inflation-protected securities and municipal bonds adds a measure of safety, says Ford O’Neil, a co-manager of the Fidelity Total Bond Fund. Most investors understand that diversification and patience in the stock market is the best approach. Says O’Neil: “It works for bonds too.”