Finally, A Reason to Spend: Interest Rates Down

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Sometimes things don’t turn out exactly how they’re supposed to.

The Great Recession began more than three years ago. And, although we’re in a better place now than we were then, we’re still lingering in the doldrums.

One of the ways that the Federal Reserve strives to pull us out of mires like this one is to keep interest rates low. And that it’s doing.

Last month, the Fed decided to keep the federal funds rate—a benchmark for interest rates around the country—at its current low rate and has no intention of raising it anytime soon.

If you’re earning less interest than the rate of inflation, your money basically depreciates over time.

Interest rates have been near zero for more than two years, the lowest level in U.S. history. Are we finally headed for a turnaround? And what do low rates mean for you?

Think of It This Way…

If you could borrow a lot of money and barely pay any interest on it, you’d be encouraged to borrow and spend, right? Meanwhile, if you barely made any interest income from your savings account, you wouldn’t have a lot of incentive to actually save. That’s what’s happening right now.

(Also, if inflation is higher than the amount you’re earning from your savings account, your money is, in a sense, “eroding.” To see what we mean, read this.)


Low Interest Rates Encourage Spending Over Saving

The Fed had this in mind when deciding to lower rates in the first place. The goal was to help the U.S. economy get out of the crisis by encouraging people to spend, stimulating the economy.

Unfortunately, the world isn’t perfect, and the economy’s improvement has been lackluster. Pundits propose two main reasons:

  1. The Fed’s policy isn’t working because too many businesses and families already have a lot of debt, preventing them from taking out loans.
  2. Banks may be hesitant to lend because they’re still recovering from the housing crisis, which was caused by giving cheap loans to individuals who couldn’t keep up with payments.

A full rebound in the economy may take a while, but in the meantime, you can make the most of the situation as it is.

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What This Means for You

First and foremost, do what’s best for you–regardless of the economy. That means having an emergency fund as a security blanket, keeping up with minimum balances and continuing to save for goals that are important to you.

But beyond that, there are ways to take advantage of the current economy. For example, now is actually a good time to pay off debt (and not just because we’re supposed to say that). Economically speaking, money is “cheaper” than usual right now, so you’d be repaying debt with cheaper dollars, costing you less in the end. Similarly, if you were thinking of getting a mortgage anyway, rates are lower now than in the past. (If you already have a mortgage, find out if you can refinance at a lower rate here.)

We’ve put together a chart with some ways that interest rates affect your finances:

High Interest Rates Low Interest Rates
Banking Good returns on your savings Bad returns on your savings
Getting A Loan More expensive Good time to get mortgage, business loan, etc.
Paying Debt Debt is more expensive Great time to pay off debt
Investing “Safer” investments still get good returns Good way to make returns since bank rates are so low
  • http://twitter.com/Purplenutmeg1 Enide Dufresne

    I think spending is a good idea, it just gets a little tricky when you want to actually save up for a deposit on a mortgage, while at the same time payback debts. Then you have to ask yourself which has the highest opportunity cost. 

    • Jen

      The best way is to save/repay in a ladder system:
      Split your available dollars into groups;
      pay the highest interest debts with the largest group of $;
      pay the smaller interest debts with smaller amounts next (minimum payments if you have to, for a few months here or there);
      put whatever is left aside into emergency fund & down payment savings (always leave a little aside to do this, even $20-50/mo.).

      As the largest debt is paid off, split those freed up dollars into the others (both debt & savings). Eventually, debts go away and all you have is $ going into savings. But in the meantime, you have some savings available for emergencies, to avoid going further into debt (huge help!). I’ve had many pitfalls along the way eat up my savings (mostly car repairs), but after a few years, the debts are gone while the assets are stronger.

  • Anonymous

    You need to see this!

    Who’s Afraid of the Big bad Bank?: An Uncensored Investigation of the U.S. Federal Reserve – One of the most controversial institutions of our time [from Stanion Studios] – Part 1 of 8:

    http://www.youtube.com/watch?v=_M_Rh_fgKEQ

  • Anonymous

    You need to see this!

    Who’s Afraid of the Big bad Bank?: An Uncensored Investigation of the U.S. Federal Reserve – One of the most controversial institutions of our time [from Stanion Studios] – Part 1 of 8:

    http://www.youtube.com/watch?v=_M_Rh_fgKEQ

  • Anonymous

    You need to see this!

    Who’s Afraid of the Big bad Bank?: An Uncensored Investigation of the U.S. Federal Reserve – One of the most controversial institutions of our time [from Stanion Studios] – Part 1 of 8:

    http://www.youtube.com/watch?v=_M_Rh_fgKEQ