3 Reasons To Be Interested In Interest Rates

Allison Kade
Posted

What do interest rates and breakfast cereal have in common?

Okay, we don’t actually have a hilarious joke answer, but we do have a personal finance expert who sees a real similarity.

In the wise words of LearnVest Investing Expert Manisha Thakor, “Low interest rates are like the financial version of Frosted Mini-Wheats. They have two very different sides.”

Interest rates are historically low right now. Alison Rogers, LearnVest’s Real Estate Expert, points out that there was a small jump in rates in December, but there’s ongoing discussion over whether they’ll stay low for at least a while to come.

This means a few things for consumers like us, both good and bad:

1. The Sweet Frosting: Good Time To Pay Down Debt

Manisha told us that low interest rates make this a good time to pay down any debt. This can range from high interest credit card debt to student loan debt, and it can even mean making extra mortgage payments on your home, as long as you never neglect the minimums on anything. This is true because paying off debt now will give you the “guaranteed return” of whatever your interest rate is on that debt. For example, say that your credit card charges 15% interest and your savings account only gives you a paltry 1%. Paying 15% on an amount and making 1% by saving the same amount will leave you shelling out 14%, but simply getting rid of that 15% obligation altogether will be like making an extra, well, 15%. So, getting rid of your credit card debt straight away would actually leave you with more cash in the end than if you saved that same amount.

2. The Sweet Frosting: Good Time To Buy A Home

Alison suggests: “Think of an interest rate as the cost of money. If you’re a homebuyer and interest rates are low, then the cost of that money is low.” That means you can borrow more money and pay less interest in exchange for the loan. If you’re already looking to make a big purchase like a house, this is a great time to lock in that low cost. For example, interest rates on 15-year and 30-year fixed rate mortgages for qualified buyers are currently around 4.4% and 5.0%, respectively. Now, don’t rush out to buy a house simply for the sake of it, but if you’re already considering buying a home, have a solid credit score and the cash to make a 20% down payment, and find a home where the monthly all-in cost of ownership is around a quarter of your take-home income, now is a wise time to take the plunge.

3. The Less Delicious Whole Grain: Your Savings Won’t Have So Much Oomph

The whole reason rates are so low right now is that the economy isn’t growing very fast and the government is trying to stimulate growth by making money cheap to borrow, in the hopes that people will spend more. This also means that the interest rates you’d get by putting your cash in a savings account, money market fund, or a certificate of deposit is also super low. “If you think about it,” Manisha says, “this makes sense, since the whole point of having low interest rates is to get money moving back into the economy to stimulate GDP (gross domestic product). Rewarding people for staying in cash would be contrary to that goal.”

Some Ways To Sweeten That Cereal

Especially since it’s going to be hard to earn great interest on your savings accounts, remember that LearnVest recommends putting extra savings into the stock market as long as you won’t need that money for five years or more—and as long as you already have a full emergency fund and have paid off all bad debt. Also, use this period of low interest rates to stay nimble: Be wary of investing in bonds or bond mutual funds with long maturity dates that won’t come due for quite a while. When interest rates are low (like now), bond prices tend to be higher, and when interest is high, bond prices tend to be lower. Since we’re currently facing low interest, don’t commit to long-term bonds now. If you did, you might lock yourself out of the chance to pounce on better bond prices once interest goes back up. So, pause now to make sure that your average maturity or duration on bond investments is on the shorter side, defined as two years or less.

Alison also suggests that this could be a good time to invest in yourself. For example, now could be the time you finally take a continuing education class that could earn you more in the future, since that low-interest savings account isn’t really earning much to speak of.

In the end, all-time low interest rates can be both good and bad, but the trick is to accept the situation and make the most of it. As for the Frosted Mini-Wheats metaphor, we leave all cereal choices up to you.

  • Anonymous

    I like that: “Think of an interest rate as the cost of money.” Will do.

    • Michelle

      Agreed! A smart and simple way to think about interest rates.

  • Anderson12

    An additional way to “sweeten the cereal”. Think about investing in a Roth IRA instead of letting your cash languish in low interest accounts. You can usually buy funds (of various risk/opportunity rates) that get returns based on the stocks they consist of.nnYou can invest up to $5k a year and…anything pricipal can be taken back out without taking the penalty for early withdrawal! The only thing you can’t touch is any interest it earns….but since interest rates at the bank are super low, you probably won’t miss not having access to that. And any interest you earn will be there for you in retirement. Makes a great emergency fund.nnCaveats – check which funds you buy…some won’t let you sell for a year after buying them (some will let you sell any time) and some have fees (avoid if possible). Also there is SOME risk with any funds. So it’s possible that you will actually lose money. Though provided the market keeps recovering, you stand to gain.

    • Anonymous

      Thanks for sharing your insight!

  • Marie

    This is a fun way to present what could have been a dry topic (it helps that I love cereal!). nnI am working on paying down my debts and feel a little sad that it’s not a good time for me to take advantage of good home prices/loan interest rates. At the same time, I know I am not ready for a house, so I am holding off on that.

    • Anonymous

      Kudos on working to pay down your debt! We know it can be a long process that requires a lot of patience and discipline — but keep at it and remember, we’re here if you need any help!

  • Ezonomics

    Thanks for highlighting the very important topic of interest rates and how they relate to personal finance. It is particularly good timing as in our poll this week, 57% of respondents thought interest rates would rise in 2011. The full results (with ING Commercial Banking rate forecasts) are here: http://www.ing.com/ezonomics/polllanding.jsp?left=false&docid=481749&poll_id=481749