Like low interest rates? That answer can vary depending on which side of the equation you’re on. Since the global economy has been scraping along the bottom of what seems like very cheap money, what does this mean for you? First, let’s look at both sides of the equation: 1) a loan, where you pay a certain amount to borrow money; versus 2) savings, where you are paid a certain amount to store or lend your money.
Basic economics suggests that low interest rates on loans afford you more purchasing power. And in quite the opposite manner, higher interest rates on loans diminish your purchasing power. Knowing this, have you ever considered how much more your mortgage payment would be if the interest rate was at the same level as it was in 1981?
Assume the following example: Today, a fully amortized home mortgage starting with a $500,000 balance financed for 30-years at a 4% interest rate would have a monthly payment of $2,387. While that might sound like an affordable payment (no taxes or insurance are included in this example), what if current mortgage rates were offered at October 1981 levels?
In October of 1981, a home mortgage (while also paying an additional 2-percentage points in order to get it) was averaging 18%!! That would mean the same $500,000 loan would cost a homeowner $7,535 per month. Again, that figure does not include taxes or insurance. While this might sound like sheer madness, read on to hear the other side of the equation.
Last week, the Federal Funds rate was increased from 0.12% to 0.37%. This was the first increase in 9 1/2 years and was a wake up call signifying that the cost of borrowing and lending is beginning to move higher. Despite this small increase, the rate remains historically low and explains why the annual percentage yield on a one-year Certificate of Deposit (CD) at either Citibank or Wells Fargo is 0.15% and 0.05% respectively. (Source Citibank and Wells Fargo online)
In contrast, in July of 1981, the Federal Funds rate was at stratospheric 19.04%! This was what allowed one-year CDs to be issued a month later at nearly 18%.
Source: (http://www.federalreserve.gov/releases/h15/data.htm)
While interest rates play a major role in determining how much you pay or receive, they are usually indicative of the current rate of inflation. That means the rates received in CDs aren’t really growing your purchasing power; they’re merely keeping pace with inflation. So enjoy these historically low rates (for loans) while they last.
If you’re considering ways to invest your money for income, call our office to schedule an appointment. Here, we can discuss various ways you might be able to get a better return than a CD while attempting to mitigate the downside effects of an increasing interest rate environment.