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What a bump in interest rates could mean for your personal finances

Federal Reserve Chair Janet Yellen speaks at the Economic Club of Washington. The Fed is considering whether to raise interest rates, which will affect the cost of mortgages, corporate debt and the value of the dollar. (Joshua Roberts/Reuters)

Here we are again, fretting about a possible increase in interest rates by the Federal Reserve and what a bump would mean for our personal finances.

When it comes to your money, you have to prepare for the worst and hope for the best. There is no use worrying about what the Fed is going to do because it’s out of your control.

I know you are probably busy shopping and planning for the holiday and don’t need the extra anxiety of a potential interest rate increase. So here are just two steps you’ll need to take when an increase finally comes:

Set a savings goal. Americans' savings rate is improving, but it's still too low.

The average personal savings rate as a percentage of disposable income was 5.6 percent in October, according to the Bureau of Economic Analysis. That’s better than its lowest point of 1.9 percent in July 2005 but nowhere near the peak of 17 percent in May 1975.

What percentage of your net pay are you saving?

How much are you putting toward an emergency fund, retirement or your child’s college fund? You should also have a separate savings account for unplanned expenses that I call a “life happens fund.” The beauty of this fund is that you don’t have to feel guilty about withdrawing money from it because its purpose is to cover shortfalls for a major car repair or other expenses not included in your budget. The “life happens fund” keeps you from dipping into your emergency fund, which should be reserved for dire situations such as a job loss.

Any rate increase by the Fed probably will be small and won’t significantly improve what you earn on your savings. That means that, yes, you are still going to be getting a pitiful amount of interest on whatever you’ve stashed at a bank. Nonetheless, keep building up your savings. Don’t be deterred by low rates because this isn’t money you need to grow. It’s money you need to be there in case of an emergency or unexpected expense.

What percentage of your income should you save?

As much as you can.

Experts say a good target is 10 percent. But push yourself. Try for 15 percent or even 20 percent. As people earn more, they tend to elevate their lifestyle (eating out more, bigger house, pricier vacations), which of course leads to a higher cost of living. If you set your savings bar too low, you’ll just boost your spending because you’ll think you’re saving enough.

The data continue to show that most people aren’t saving enough for retirement. And they aren’t saving enough to send their children to college without relying on debt.

When you get a raise, rather than spend more, keep living on the lower pay and save or invest any after-tax increase. Or use it to pay down debt.

You also don’t want to set yourself up for defeat by making the target savings goal too high if you’re already struggling to pay your bills. If you aren’t saving anything, start with at least 2 percent of your net pay. That means if your net income is $3,000 every month, save $60. Then as you get comfortable with the 2 percent target, gradually increase it until you hit at least 10 percent.

Drop your debt. If you are carrying variable consumer debt or an adjustable-rate mortgage, you should be concerned. A decision by the Fed to boost rates probably will affect what you pay to borrow other people's money.

But rather than wring your hands with worry, set a goal to reduce your debt — all of it. Start with figuring out your debt-to-income ratio, which is a good indicator of your financial health, according to the National Foundation for Credit Counseling.

To figure out your debt-to-income ratio, divide all your monthly debt obligations — mortgage, auto or student loans, and minimum credit card payment — by your gross monthly income.

“The sweet spot is 36 percent,” the NFCC says.

Lower is even sweeter.

You can find a debt-to-income ratio calculator at

If your ratio is high, you need to dump some debt — and fast. Once you’re rid of the debt, you can increase your savings rate.

You ought to prepare long term for the eventual end to super-low interest rates. Increases will come. Set a savings goal and drop your debt — and you’ll be ahead no matter what the Fed does.

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