What to do as interest rates rise: following these investment tips can help you keep pace with inflationary pressure

Black Enterprise, Sept, 2004 by Patrice D. Johnson, Donald Jay Korn

WHEN KARIM WEBB GOES TO CLOSE his next real estate deal, he'll try to lock in a mortgage rate as early as possible. That's because in the current market, if he allows 30 days to go by on a deal he could end up paying more. The 30-year-old mortgage banker with United International Mortgage Bank in Los Angeles owns seven residential properties, including his home, and he's contemplating buying more. Webb is concentrating on markets outside of Los Angeles, where prices are still affordable. "I think the Los Angeles [and] San Francisco area properties that have doubled in value over the last three years are going to decrease in value at a greater rate than [properties in other] markets where average home prices aren't as high," he says.

Webb's father, Reggie, a 56-year-old McDonald's franchisee who owns 11 restaurants in Southern California with another soon to open, is planning to build an addition to his home in Claremont, California. "The cost of adding on is less than the cost of what homes are selling for per square foot," he reasons. He plans to pay for the construction by refinancing his 30-year fixed-rate mortgage at an interest rate of 5.75%, almost two percentage points lower than the rate he got five years earlier when he bought his home. He'll save thousands of dollars in interest payments.

Since hearing news of the economic recovery--increased gross domestic product growth, lower unemployment rates, and more jobs--accompanied by higher prices, inflation, and the expected rise of the federal government's short-term interest rate, both men are doing what they can now to protect their real estate and business holdings. With the economy expected to remain volatile in the short term, here are some things consumers and investors can do to help ease the pinch of rising interest rates:

Stay fixed in real estate. The average 30-year fixed-rate mortgage remains well below the low watermark for the 1990s. which was 6.83%, says Keith Gumbinger. vice president of HSH Associates, publisher of mortgage information. Still, those in the real estate market say rates are beginning to feel upward pressure.

Reggie took out seven loans to acquire or renovate his McDonald's franchises. Most of the loans have a life of seven years and interest rate caps that range from 2.5% to 4.5%. Two of the loans are fixed; the other five have floating or adjustable rates that can be fixed once during the life of the loan. Reggie says he tries to keep a blend of fixed- and floating-rate loans so he can benefit from market conditions on at least a portion of the debt he carries: "If I see interest rates beginning to rise dramatically, and it looks to me like they will continue to rise, I can fix some loans at whatever the fixed rate is on that date." Reggie intends to obtain a fixed-rate loan to acquire his twelfth franchise. "That way, I'll lock in my rate [at near historic lows] and it won't go up over the course of the seven years," he explains.

To select the best mortgage, you should have a pretty good idea of how long you plan on being in the home, says Gumbinger. A fixed-rate mortgage remains a very attractive deal and is probably best for anybody who intends to stay put for about seven years.

For others, 30 years of fixed-rate stability may not be worth the price. For those buyers, Gumbinger suggests hybrid adjustable-rate mortgages (ARMs), which feature a fixed interest rate usually for three, five, seven, or 10 years until they turn into traditional adjustable-rate mortgages. In this category, 5/1 ARMs are the most popular; they're fixed for five years and adjusted annually thereafter. Currently, ARMs are available at an interest rate around one percentage point below the comparable 30-year fixed rate.

If you're considering refinancing to get cash for home improvements or to switch to a better interest rate, compare your current spending to the cost of getting a new mortgage. If you've been in your home for a while or have an extraordinarily low interest rate, it doesn't make sense to refinance your loan to get cash at the expense of adding years to your mortgage at a higher interest rate.

If you are currently stuck with a sub-prime loan (high-interest loans given to people with poorer credit ratings), you might consider a longer-term fixed-rate mortgage if you qualify. It may buy you some certainty in your monthly budget as interest rates rise.

Maintain a diversified portfolio. The stock market generally responds negatively to rising interest rates, meaning that many issues may lose value. While some investors see this as a great opportunity to go hunting for discounted stocks, this is also a time when investors might do well to pull back their exposure to stocks by about 10% to 20%, says Sanford Coggins, former Merrill Lynch financial adviser and investments vice president.

Coggins advises clients to diversify their equity holdings so that nearly every sector is included. For example. 10% or 15% of equities could be devoted to the utilities and energy sectors, which generally do well in a money-tightening environment. Coggins suggests simultaneously adjusting your portfolio weightings away from sectors that are sensitive to interest rates, such as financial services. "The average investor should probably look at the S&P 500 weighting and then balance off of that," he says. "Then take [industries] such as energy, healthcare, or utilities and start moving ever so slightly [until about] 15% of the portfolio is invested in those sectors." According to Coggins, this strategy should help the investor outperform the S&P but not lose his shirt if he's wrong.