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Why Lending Rates Can’t Stay Low Forever

This article was written by in Personal Finance. 2 comments.

The Federal Reserve sure gets a lot of media attention. And yes, the discussion of when and if the Fed is going to raise interest rates can get a little tedious, but it still probably deserves some of your attention because interest rates are woven so deeply into the fabric of household finances.

The Fed finally raised rates at the end of 2015, but you might not be familiar with all the background. The Fed had sunk rates to unusually low levels as a response to the Great Recession. Why? Low interest rates help stimulate growth by making borrowing cheaper, and they also support asset prices from housing to the stock market.

At the same time, rates can’t stay near zero forever. When interest rates are too low, it can encourage inflation. It also leaves the Fed with very little room to lower rates the next time the economy enters a recession.

By the way, as you have probably noticed if you’ve been looking at savings account or CD rates over the past five years, current monetary policy also leaves savers with precious little interest earned on their deposits.

Officially, the Great Recession ended over six years ago, meaning the current economic expansion is already longer than the average post-World War II expansion. So why did the Fed wait so long and only raising rates in small increments?

Historical view of federal lending rates

This is a chart that shows a historical view of the federal funds rate

Credit: St. Louis Federal Reserve


Consider market rates while the Fed calms investors

For much of the past six years, the economic recovery seemed fragile and halting. More recently though, the Fed seems overly concerned with not upsetting stock market investors.

The bottom line, though, is that when the Fed takes action market interest rates are likely to follow the same trend line.
What are market interest rates? These include investment yields on the bond market as well as the type of interest rates you encounter frequently in everyday life, such as deposit rates at banks and rates charged to borrowers on things like mortgages and credit cards.

Here’s where interest rates could affect you

Specifically, what does all this mean to you? Here are some examples of how you might be affected by rising interest rates:

  1. Buying a home could get more expensive. Recent years have seen record low mortgage rates, but any lender making long-term loans is going to be very sensitive to signs that inflation is on the rise. When mortgage rates start to rise, they can move very quickly.
  2. Selling a home could get more difficult. On the other side of the ledger, if mortgage rates make buying more expensive, would-be buyers will have less money to put into the price of the home — and that could come out of your end of the deal.
  3. Even renting could become more expensive. Higher interest rates could affect your housing costs even if you don’t plan on owning a home. Landlords are affected by higher mortgage rates, and you can expect them to pass on whatever costs they can to their tenants.
  4. Credit card debt could get more expensive. Carrying a balance on your credit card is very costly — such balances are charged an average of 13.49 percent, according to recent Federal Reserve figures. If inflation continues to rise, expect that number to go up too.
  5. You could finally start to earn some income on your deposits. The plus side of higher rates is that people who have been earning next to nothing in savings accounts and other deposits could finally start to earn a decent rate of interest again.

Some of the impact you can’t do anything about, but there are ways you can prepare for rising interest rates nonetheless.

What should you do about rising rates?

Since interest rates can start to rise with or without the Fed’s intervention, here are some things you can do to be prepared:

  1. Refinance while you have the chance. Mortgage rates have been rising and could go even higher if inflation continues to firm up. If you haven’t taken advantage of the opportunity to lock in a lower mortgage rate, now may be your last chance. If you can afford a higher monthly payment, consider refinancing to a shorter mortgage to get an even lower rate. This will cost you less interest in the long run because you will be paying interest over fewer years. Also, if you have an adjustable rate mortgage, it might be a good idea to refinance to a fixed-rate loan before rates rise much more.
  2. Be decisive about buying a home. No one should rush into buying a home; but if you have thought it through and were planning to move ahead, you might want to bump it to the top of your list of priorities. Getting in before mortgage rates rise could save you money for years to come.
  3. Shop actively for savings account and CD rates. When interest rates start to rise, some banks are going to react sooner than others. When it comes to savings account and CD rates, you want to look for the banks that raise rates first and farthest. A rising rate environment is a time when some active shopping for bank rates can really pay off.
  4. Keep CD maturities short. Speaking of CDs, keep maturity dates on the short side so that you can roll them over more frequently as rates rise. You might consider a CD ladder so that you will have money coming available for reinvestment regularly. An alternative is to look for CDs with relatively mild penalties for early withdrawal, so you can continue to earn the higher rates of CDs with a longer term and yet break out of the CD at a reasonable cost should rates rise sufficiently.
  5. Pay down credit card balances. You should be trying to do this anyway, but think of rising interest rates as added motivation.

The bottom line is that when interest rates rise, savers win and borrowers lose. That is yet another reason you should strive to get yourself more on the saver side of the equation.


Updated March 23, 2016 and originally published February 20, 2016. If you enjoyed this article receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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{ 2 comments… read them below or add one }

avatar 1 Anonymous

Really an interesting article about the inflation in Economic growth.

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avatar 2 Alexander C Huynh

Nice article! What is amazing is the large number of people who are eligible for significant refi’s that don’t take action.

Is it possible for rates to go lower though?

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