The Good & Not So Good of Low Interest Rates

We are in a period of the lowest interest rates ever.  If you are borrowing money, these are some of the best of times.  We have never been able to borrow money for homes, businesses, cars, etc. as low as we have been able to this past year.  As a result, individuals and businesses are borrowing at the highest levels ever seen.

According to a recent article in MarketWatch, US corporate debt was a record $10.5 trillion as of August 31, 2020.  That is a drop in the bucket compared to the federal government with over $28 trillion of outstanding debt.  Low rates have allowed businesses to develop, expand and hire.  They have also substantially reduced the amount of interest that the federal government must pay to sustain the national debt.

Conversely, fixed-income investments have never paid less to investors who have bought bonds, certificates of deposit or fixed annuities.  This has the potential to force retirees and other risk-averse investors to buy investments that provide a higher return but with higher volatility. 

But what does all this mean to you and me?  Low interest rates reduce our interest expense when compared with higher rates.  While all-time low rates occurred last year, the current mortgage rates for home buyers are still close to historic lows.  With rates so low, it becomes worth discussing the benefits and risks of paying additional principal to a mortgage for an earlier payoff as well as paying less interest.  Or you might consider the possible tax advantages of mortgage interest as well as long-term inflation.  It might be better for growth-oriented investors to make the minimum loan payment and put any extra towards investments that have the potential to achieve a higher rate of return.

For people that are closer to retirement, own a home and still have a mortgage on the property, refinancing at a low rate for a longer-term can reduce the monthly cost of housing.  This can free up monthly cash flow for other necessities.

While low rates make buying things more attractive to all of us, it is still something to avoid or at least limit.  Here’s why: a buyer might get a 0% interest rate on a new vehicle, but that car will probably lose 10% to 20% of its value as soon as the new owner drives away from the dealership.  Come to think of it, that new car smell is probably far more expensive than Chanel or other perfume on the market!

The risk of any borrowing is that you must make timely payments in full.  Lenders don’t care if you change jobs, have health care expenses or lost big at the horse track.  (Please watch the movie “The Big Short” for an educational and entertaining look at the mortgage crises of 2008.)

Today’s low rates are indeed an opportunity, but borrowing money can be also risky.  I hope this article has given you financial insights to help you become a more knowledgeable borrower.  Please let me know if you have any questions.