Interest rates not only play a role in the overall economy, but they also affect personal finances. In the United States, the Federal Reserve continuously monitors the overall state of the nation’s economy. As a result, this government office has the power to raise or lower lending rates based on economic trends, and in turn these decisions play a direct role in determining how much interest consumers will be charged for borrowing money as well as how much banks and credit unions will pay their clientele for using their money.
So why do these rates go up and down in the first place? Wouldn’t things be far simpler if they just stayed the same?
That sounds ideal, but unfortunately, the science of economics doesn’t work that way. When interest rates are low, this enables consumers to purchase more material goods. Revenues for retailers and real estate sales increase, and seemingly everything is good. Eventually, however, greed sets in, and everyone from the initial suppliers to the manufacturing facilities all the way up to the final retailers want more compensation for their efforts, which raises prices and results in inflation. Thus, in an effort to prevent this from snowballing out of control, the Federal Reserve (the Fed for short) will raise lending rates in hopes of making borrowing money less appealing. On the other hand, when overall economic growth is stagnant, the Fed will lower interest rates in hopes of stimulating buying power. In short, if interest rates were too low, a loaf of bread at the supermarket would eventually cost $20.00 while excessively high interest rates would result in everyone but millionaires living out of cardboard boxes and tents. These rates therefore perpetually fluctuate to thwart either of these two scenarios.
The trick, then, is to make major purchases when the rates drop, and to cease buying when they increase. What must be kept in mind here is that while lower interest rates lessen the expenses of purchasing, this is also an indicator of tougher times. While lower lending rates are obviously advantageous to consumers, the downside is that those savings accounts, CDs, and other investments like mutual funds and stocks are likely paying peanuts. Conversely, when lending rates are higher, so is the interest and rate of return on those bank accounts and investments. However, as long as this trade-off is understood, you can still take advantage of lower interest rates.
It’s not uncommon today for households to have thousands of dollars in credit card debt. When the Fed reduces interest rates, it admittedly can take some time for this to trickle down to that Visa or Mastercard bill, but eventually, it will. Credit cards make it easy to acquire things you want or need without worrying about having cash up front, but unless you are able to pay off the balance each month, the interest will eat your finances alive. Hence, if you choose to pay only the minimum monthly obligation to the institution that issued the card, you could still be paying off that $1,200 car repair or that $3000 trip to Disney World you initially charged for the next five years. When that rate finally does produce an effect on that piece of plastic, it can be paid off faster.
Better yet, why wait for that to happen when that outstanding balance can be borrowed from a bank and paid back with a much lower rate? If you do this, just be sure to cut that card up into pieces. Another option is to apply for one of those 0% introductory rate cards everybody gets in the mail and transfer all your existing credit card balances to the new card. Just don’t add new purchases to it, or your problems will start all over again once that zero percent introductory rate expires. The message here is to pay down high-interest credit cards.
A home or other real property,such as a business, will represent the biggest expense people will have. Most will not have tens or hundreds of thousands of dollars to pay cash for a house or that restaurant or hair salon they’ve always dreamed about, so the objective here is to get financing for these assets when interest rates are at their lowest. On a 30-year mortgage for $200,000, just a difference of 2 percent will lower that monthly payment by roughly $350. Now multiply that $350 by the 360 months of the loan term. That’s an out-of pocket savings of over $125,000 over that 30 years. Another popular option is to refinance your home when rates drop to obtain comparable results.
Even on a more modest purchase, such as that $30,000 car, a two percent lower interest rate would equate to a savings of over $,1000 in finance charges over a typical 5-year loan. The best car deals of all involve zero percent interest, but they usually have to be paid off in 36 months as opposed to 60. In a fashion that responds to how the Fed operates, some slow-selling cars will be offered at zero percent interest for an entire five years, but the manufacturers can only do this for so long. As an example, Saturn, a division of General Motors, had many such incentives over their production run, but the car maker never turned a profit and eventually went belly-up. The moral here? It’s great to be able to purchase a car with free financing, but if the manufacturer seems to offer this fairly often, you will run the risk of being stuck with something that could become obsolete. Therefore, when making such a large purchase, you should do research to ensure that whatever you’re buying isn’t in danger of suddenly being pulled off the market.
Invest in charitable contributions. By investing extra cash into charities, you will first get a tax break. Best of all, once certain investments into charitable organizations reach a specific rate of return, the amount that exceeds that will go to designated beneficiaries upon your death. It’s also a good time to review your current investments with your financial advisor. When interest rates are low, your rate of return on such investments may not be doing so well, either. Remember those CDs and savings accounts? This is a time to look into shifting them around and diversifying that portfolio.
If you have a child that intends to go to college, lock in those student loan rates while they’re low. This will make them far easier to pay back. At the same time, you’ll be helping the state of the economy by reducing student loan defaults that are partly to blame for the mess this country got itself into a few years back.
To conclude, it is far more sensible to make major purchases when interest rates are low. The most effective way to accomplish this objective is to follow these rates, but make absolutely sure you read the fine print. It will likely take years for the US to recover from the financial woes of over-lending that got out of control by the late 2000s, and thus the best advice of all is to be certain that you can afford to pay those balances in a timely manner. Nobody wants another Great Depression.