contributed by LearnVest
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.Print