Jan 25th, 2008
The Effects of Changing Interest Rates
Interest rates are headed lower. For some people, this is a huge benefit; those with variable rates on credit cards and mortgages could benefit nicely, or those who want to refinance mortgages with high (or at least relatively high) fixed rates. For others, like myself, this is more of a drawback than a benefit; those interest rates I was getting on my money market accounts just dropped.
When interest rates lower, there’s less incentive to save money and more to spend. Borrowing becomes less costly, so people and businesses are likely to extend themselves more. Spending is the engine that drives the economy, so increasing spending tends to pump up the economy. That’s the idea behind lowering rates (and also the idea behind the still in progress and not necessarily all that well thought out tax rebate checks that Washington is still working out): if you can increase spending, you can prop up the economy. The problem with a fast growing economy is that it typically is accompanied by fast growing inflation, so you don’t always want such a thing.
When interest rates go higher, the economy slows down. People and businesses are less likely to borrow because they’ll pay more interest and more likely to save because they get more interest. This is a desirable process if inflation is high.
If interest rates drop (and it’s quite possible they’ll continue to drop a bit more), consider trying to get your debt refinanced at lower rates than you’ve been paying. If you’re considering a major purchase that you must borrow money for (a house is the best example), it might be a great time to do so. Where an interest rate drop will hurt you is if you have money in money market or other savings accounts; CDs have fixed rates so they won’t hit you with a rate drop until they mature. When interest rates increase, it may be time to seek out higher rate money market accounts and CDs to put your emergency fund and other can’t-afford-to-lose-money into.
Understanding the effects of interest rates on your own finances can mean hundreds, if not thousands of dollars difference every year. Lower rates are a bummer for my personal situation, but it can be a Godsend for others. Higher rates would be helpful for me, but it could drive others over the financial edge. Knowing what to do in each interest rate environment can improve your personal financial situation by hundreds or thousands every year.
