The economy may be plodding toward recovery, but it isn’t moving quickly enough to justify an increase in interest rates any time during the next two years according to the Federal Reserve. The Fed’s first announcement of lowered interest rates came during the recession in 2008, and the latest extension means that rates will remain at historic lows for longer than expected. So how might this impact you?
A prolonged low rate environment has several implications for people at different stages of life. Some are positive, but others aren’t so rosy. The good news is that it makes borrowing money cheaper, which is great if you’re considering making a major purchase like a car or home. On the other hand, it indicates a slow economic recovery, which may negatively impact unemployment and the real estate market. If you’re saving for retirement, lower than expected yields on investments could actually impede your ability to meet your retirement goals if you don’t revisit and adjust your financial plan.
What it means: The economic recovery is slower than expected.
The Federal Open Market committee’s decision to keep interest rates low indicates that the Fed is not particularly optimistic about the economy and expects a slow recovery. If we continue to be plagued with high unemployment rates, sluggish consumer confidence and lackluster growth, consumers will have no real motivation to spend, and it may be slow going if you’re looking for a new job or trying to increase your savings.
The good news: It’s cheaper to borrow
The Federal Funds rate is the interest rate that banks charge each other for overnight loans, and acts as the Federal Government’s primary tool for stimulating the economy. The idea behind it is that low interest rates encourage spending. In theory, consumers who have access to credit at low rates are more likely to borrow money for mortgages, cars or other purchases, and then use additional capital for spending, which stimulates the economy and creates growth.
If you’re looking to buy a house or car, or to finance student loans, you have a great advantage. With long-term loans like these, the cost savings from locking in a low interest rate loan can have a significant impact on your bottom line over time. If you’d like to see how this works for yourself, run two mortgage scenarios on an online calculator using the same amount and length of the loan, and compare a four percent to a seven percent rate.
This doesn’t mean that you should rush out to borrow simply because rates are low; everyone should only take on an appropriate amount of debt as part of a well constructed financial plan. Interestingly, the economic environment has also made lending standards stricter – so even though it’s less expensive to borrow, it may be tougher to qualify.
The bad news: It may impact your retirement.
Investors have long looked to bonds as a part of their overall asset allocation or as investment vehicles to produce retirement income. If you are planning for retirement – regardless of your age – the current economic environment may prove challenging.
In the past, financial planners and investment professionals have looked at historical interest rates to create assumptions for return models. In plain English, that means they used interest rate numbers from the past to calculate how much invested money might grow, or how much income bonds would generate. Today traditional investment strategies, which typically have moderate interest rate assumptions behind them, are unlikely to enable investors to meet their goals. With rates at all time lows, consumers may find themselves rethinking their allocations or looking for guaranteed income elsewhere.
Low interest rates may impact your financial goals positively or negatively – or possibly both ways. Consider meeting with a professional financial planner who can help you put together a plan to achieve your financial goals while taking into consideration the current low interest rate environment.