- How to adjust your borrowing, saving and investing as interest rates continue to decline
- Borrowing: Don't overdo it
- Saving: Expand into riskier options
- Dividends: Red flags for reductions
- Retirement: Look to ease pressures
- Low Interest Rates Have Benefits … and Costs
- Benefits of Low Interest Rates
- Costs of Low Interest Rates
- 4 things to do with your money now, while interest rates are low
- 1. Consolidate credit-card debt
- 2. Refinance your mortgage
- 3. Refinance your student loans
- 4. Open a high-yield savings account
- Smart moves to boost your savings even with low interest rates
- You can still make smart money moves
- Compare savings rates from other banks
- Eliminate existing bank fees
- Consider account sign-up bonuses
- More from NerdWallet:
- As Interest Rates Plummet, Here’s How Savers Can Stay Above Water
- What’s Going On, Anyway?
- Left Behind
- So, What Can You Do?
- Forget Interest, But Continue Saving
- Start Making Bigger Changes
- Systemic Changes
- Looking Ahead: How Low Will Rates Go?
- Light At the End of the Tunnel
How to adjust your borrowing, saving and investing as interest rates continue to decline
USA TODAY personal finance reporter, Janna Herron, explains how changes in the Federal Reserve's interest rates affect your financial accounts. USA TODAY
Interest rates have been declining for most of the past decade, and yet, the low-rate trend looks it could persist for quite a while longer.
The Federal Reserve just cut short-term interest rates amid signs of economic slowing. Consequently, it's not a bad idea to assess your exposure to low rates and your opportunity to capitalize on them, when it comes to borrowing, saving and investing.
Borrowing: Don't overdo it
Rates on some types of loans are dropping again, and that can make it enticing to go out and borrow more money to purchase all sorts of things — homes, vehicles, appliances or whatever. But financial adviser Daniel Hill of D.R. Hill Wealth Strategies in Richmond, Virginia, suggests caution.
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“People tend to overextend themselves, which is what happened” prior to the Great Recession about a decade ago, he said.
If you must borrow, Hill suggests being careful not to extend your terms. Loans going out six or seven years on vehicles, once unthinkable, have become common. Lengthy payback periods could be a sign you can't afford the item otherwise. Besides, you would be locking in payments for many years on assets, cars and trucks, that will lose a substantial amount of value over that time.
(Photo: Getty Images)
Low rates do provide an opportunity to refinance existing debt and even use it to pay off higher-cost loans.
Neal Van Zutphen, a certified financial planner at Intrinsic Wealth Counsel in Tempe, cites two common rules for refinancing a mortgage. If you can offset your loan closing costs with lower monthly payments within a year or so, refinancing could be worthwhile. So, too, if you can shave at least half a percentage point on your interest rate.
The interest rates on mortgages are among the cheapest forms of borrowing and thus can be a shrewd way to pay off more costly loans such as credit-card balances. You just don't want to squander the proceeds on vacations or other unnecessary spending.
Saving: Expand into riskier options
Savers have been hurt by the trend toward drastically lower rates over the past decade or so. Nor will they get much help in the form of higher yields anytime soon. In fact, yields on certificates of deposit, money market funds and other short-term instruments have started to ebb in the wake of the Fed's latest rate cut.
To generate more yield, you might need to venture into investments that carry at least some principal risk, such as short-term bonds and bond funds. The longer the term on a bond, the greater the possibility that prices could drop if interest rates rise. Conversely, longer-term bonds will enjoy more capital appreciation if rates fall further.
If you're depending on yield to make ends meet, it might be time to consider stocks and stock funds. (Photo: Susan Tompor, Detroit Free Press)
If you're depending on yield to make ends meet, it might be time to consider stocks and stock funds. Sure, you face volatile prices, but hundreds of stocks now are yielding 2% or more, with dozens in the range of 4 to 5% or higher.
That means these dividends exceed the interest paid on many types of bonds, including federal government bonds and municipal issues sold by cities, counties and state agencies.
Conservative stock holdings, such as dividend-paying companies, are a logical extension along the risk scale that starts with deposit accounts and money-market funds and extends to short-term bonds and then longer-maturity bonds.
“You just need to have different buckets of money” for diversification purposes, said Hill.
Money held in checking accounts, money-market funds and other highly conservative instruments earn the least, but you need some ready cash to meet emergencies.
Dividends: Red flags for reductions
If you decide on conservative stock holdings, don't get too greedy. An abnormally high dividend yield could signal that a corporation could be getting ready to cut the payout.
Companies don't to reduce or eliminate dividends but might need to do so. Red flags for an impending dividend cut include declining revenue and cash flow, rising debt and deteriorating business conditions.
Diversifying among high-dividend stocks, in a fund or otherwise, can mute the fallout if one or a couple companies cut their payments.
Van Zutphen s to focus on the “payout” ratio or size of annual dividend payments in relation to yearly earnings. Payout ratios above 100%, where a corporation spends more on dividends than it generates in net income, represent an unsustainable situation. But even ratios above 70% can be worrisome, he said.
One notable exception are REITs or Real Estate Investment Trusts, which typically pay out nearly all of their cash flow to qualify for an unusual benefit (their income isn't subject to corporate income taxes). No wonder these stocks tend to sport high yields.
Van Zutphen favors companies with a history not just of paying dividends but increasing them. Many of these corporations are included among the “dividend aristocrats” tracked by S&P Dow Jones Indices. All 57 companies on this aristocrats list have boosted their dividends annually for at least 25 years.
Combined, the aristocrats currently pay an average dividend yield of 2.5%. Examples include Cincinnati Financial, Cintas, Medtronic, Air Products & Chemicals, Abbott Laboratories and Procter & Gamble.
Retirement: Look to ease pressures
Low interest rates also can affect your retirement strategies.
For example, you can increase your monthly cash flow considerably by holding off on Social Security benefits. Once you claim Social Security, you lock in the same income stream for the rest of your life, increased by any COLA or cost-of-living adjustments.
If you haven't yet claimed benefits, you can boost the monthly amount each year you delay, up to age 70.
The tradeoff to waiting is that you would be forsaking Social Security payments received at an earlier age. But if you're concerned about outliving your money and expect to live to a fairly old age, delaying can be a smart strategy.
Financial reporter Russ Wiles shares five regrets to avoid when planning for or entering retirement. Arizona Republic
Social Security paid a 2.8% COLA for 2019, but inflation has slowed. The next increase could be closer to 1%, assuming the recent inflation trend persists.
The Social Security Administration will announce the new rate in October, following release of relevant inflation numbers: The next COLA will be pegged to the change in CPI-W, the consumer price index for urban wage earners, from the third quarter of 2018 to the same period in 2019.
Persistently low interest rates can be a reason to delay retirement, if you fear cash flow might be a problem. The longer you stay employed, the less work your investment portfolio must shoulder to help you make ends meet.
In fact, remaining in the workforce even an extra year or two could be the biggest step you can take to improve your retirement readiness.
Low interest rates — and low investment returns generally — also are a reason to sock away more cash in workplace 401(k) programs and other retirement accounts.
“You might need to reassess how much more you might need to save to hit your goals,” said Van Zutphen. “You might need to save more.”
Reach Wiles at firstname.lastname@example.org or 602-444-8616.
It’s never too early or late to start beefing up your retirement savings (Photo: Getty Images)
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Low Interest Rates Have Benefits … and Costs
Friday, October 1, 2010
In late December 2007, most economists realized that the economy was slowing. However, very few predicted an outright recession. most professional forecasters, the Federal Open Market Committee (FOMC) initially underestimated the severity of the recession.
In January 2008, the FOMC projected that the unemployment rate in the fourth quarter of 2010 would average 5 percent.1 But by the end of 2008, with the economy in the midst of a deep recession, the unemployment rate had risen to about 7.
5 percent; a year later, it reached 10 percent.
The Fed employed a dual-track response to the recession and financial crisis. On the one hand, it adopted some unconventional policies, such as the purchase of $1.25 trillion of mortgage-backed securities.
2 On the other hand, the FOMC reduced its interest rate target to near zero in December 2008 and then signaled its intention to maintain a low-interest rate environment for an “extended period.
” This policy action is reminiscent of the 2003-2004 episode, when the FOMC kept its federal funds target rate at 1 percent from June 2003 to June 2004.
Recently, some economists have begun to discuss the costs and benefits of maintaining extremely low short-term interest rates for an extended period.3
Benefits of Low Interest Rates
In a market economy, resources tend to flow to activities that maximize their returns for the risks borne by the lender. Interest rates (adjusted for expected inflation and other risks) serve as market signals of these rates of return.
Although returns will differ across industries, the economy also has a natural rate of interest that depends on those factors that help to determine its long-run average rate of growth, such as the nation's saving and investment rates.
4 During times when economic activity weakens, monetary policy can push its interest rate target (adjusted for inflation) temporarily below the economy's natural rate, which lowers the real cost of borrowing. This is sometimes known as “leaning against the wind.” 5
To most economists, the primary benefit of low interest rates is its stimulative effect on economic activity.
By reducing interest rates, the Fed can help spur business spending on capital goods—which also helps the economy's long-term performance—and can help spur household expenditures on homes or consumer durables automobiles.6 For example, home sales are generally higher when mortgage rates are 5 percent than if they are 10 percent.
A second benefit of low interest rates is improving bank balance sheets and banks' capacity to lend. During the financial crisis, many banks, particularly some of the largest banks, were found to be undercapitalized, which limited their ability to make loans during the initial stages of the recovery.
By keeping short-term interest rates low, the Fed helps recapitalize the banking system by helping to raise the industry's net interest margin (NIM), which boosts its retained earnings and, thus, its capital.
7 Between the fourth quarter of 2008, when the FOMC reduced its federal funds target rate to virtually zero, and the first quarter of 2010, the NIM increased by 21 percent, its highest level in more than seven years.
Yet, the amount of commercial and industrial loans on bank balance sheets declined by nearly 25 percent from its peak in October 2008 to June 2010. This suggests that perhaps other factors are helping to restrain bank lending.
A third benefit of low interest rates is that they can raise asset prices. When the Fed increases the money supply, the public finds itself with more money balances than it wants to hold.
In response, people use these excess balances to increase their purchase of goods and services, as well as of assets houses or corporate equities.
Increased demand for these assets, all else equal, raises their price.8
The lowering of interest rates to raise asset prices can be a double-edged sword. On the one hand, higher asset prices increase the wealth of households (which can boost spending) and lowers the cost of financing capital purchases for business. On the other hand, low interest rates encourage excess borrowing and higher debt levels.
Costs of Low Interest Rates
Just as there are benefits, there are costs associated with keeping interest rates below this natural level for an extended period of time. Some argue that the extended period of low interest rates (below its natural rate) from June 2003 to June 2004 was a key contributor to the housing boom and the marked increase in the household debt relative to after-tax incomes.
9 Without a strong commitment to control inflation over the long run, the risk of higher inflation is one potential cost of the Fed's keeping the real federal funds rate below the economy's natural interest rate. For example, some point to the 1970s, when the Fed did not raise interest rates fast enough or high enough to prevent what became known as the Great Inflation.
Other costs are associated with very low interest rates. First, low interest rates provide a powerful incentive to spend rather than save.
In the short-term, this may not matter much, but over a longer period of time, low interest rates penalize savers and those who rely heavily on interest income. Since peaking at $1.
33 trillion in the third quarter of 2008, personal interest income has declined by $128 billion, or 9.6 percent.
A second cost of very low interest rates flows from the first. In a world of very low real returns, individuals and investors begin to seek out higher yielding assets.
Since the FOMC moved to a near-zero federal funds target rate, yields on 10-year Treasury securities have fallen, on net, to less than 3 percent, while money market rates have fallen below 1 percent. Of course, existing bondholders have seen significant capital appreciation over this period.
However, those desiring higher nominal rates might instead be tempted to seek out more speculative, higher-yielding investments.
In 2003-2004, many investors, facing similar choices, chose to invest heavily in subprime mortgage-backed securities since they were perceived at the time to offer relatively high risk-adjusted returns.
When economic resources finance more speculative activities, the risk of a financial crisis increases—particularly if excess amounts of leverage are used in the process.
In this vein, some economists believe that banks and other financial institutions tend to take greater risks when rates are maintained at very low levels for a lengthy period of time.10
Economists have identified a few other costs associated with very low interest rates.
First, if short-term interest rates are low relative to long-term rates, banks and other financial institutions may overinvest in long-term assets, such as Treasury securities.
If interest rates rise unexpectedly, the value of those assets will fall (bond prices and yields move in opposite directions), exposing banks to substantial losses.
Second, low short-term interest rates reduce the profitability of money market funds, which are key providers of short-term credit for many large firms. (An example is the commercial paper market.) From early January 2009 to early August 2010, total assets of money market mutual funds declined from a little more than $3.9 trillion to about $2.8 trillion.
Finally, St. Louis Fed President James Bullard has argued that the Fed's promise to keep interest rates low for an “extended period” may lead to a Japanese-style deflationary economy.
11 This might occur in the event of a shock that pushes inflation down to extremely low levels—maybe below zero.
With the Fed unable to lower rates below zero, actual and expected deflation might persist, which, all else equal, would increase the real cost of servicing debt (that is, incomes fall relative to debt).
- These projections are the mid-point (average) of the central tendency of the FOMC's economic projections. The central tendency excludes the three highest and three lowest projections.
[back to text]
- The purchase of mortgage-backed securities (MBS) was a key factor in the more than doubling of the value of assets on the Fed's balance sheet. This action is sometimes referred to as quantitative easing. [back to text]
- See the Bank for International Settlements (BIS) 2010 Annual Report and Rajan.
[back to text]
- In this case, investment refers to expenditures by businesses on equipment, software and structures. This excludes human capital, which economists also consider to be of key importance in generating long-term economic growth.
[back to text]
- See Gavin for a nontechnical discussion of the theory linking the real interest rate and consumption spending. In this framework, the real rate should be negative if consumption is falling.
[back to text]
- By lowering short-term interest rates, the Fed tends to reduce long-term interest rates, such as mortgage rates or long-term corporate bond rates. However, this effect can be offset if markets perceive that the FOMC's actions increase the expected long-term inflation rate.
[back to text]
- The net interest margin (NIM) is the difference between the interest expense a bank pays (its cost of funds) and the interest income a bank receives on the loans it makes. [back to text]
- This is the standard monetarist explanation, but there are other explanations. See Mishkin for a summary. [back to text]
- See Taylor, as well as Bernanke's rebuttal. [back to text]
- See Jimenez, Ongena and Peydro. [back to text]
- See Bullard. [back to text]
Bank for International Settlements. 80th Annual Report, June 2010.
Bernanke, Ben S. “Monetary Policy and the Housing Bubble.” At the Annual Meeting of the American Economic Association, Atlanta, Ga., Jan. 3, 2010.
Bullard, James. “Seven Faces of 'The Peril.' ” Federal Reserve Bank of St. Louis Review, September-October 2010, Vol. 92, No. 5, pp. 339-52.
Gavin, William T. “Monetary Policy Stance: The View from Consumption Spending.” Economic Synopses, No. 41 (2009). See http://research.stlouisfed.org/publications/es/09/ES0941.pdf
Jimenez, Gabriel; Ongena, Steven; and Peydro, Jose-Luis. “Hazardous Times for Monetary Policy: What Do Twenty-Three Million Bank Loans Say About the Effects of Monetary Policy on Credit Risk?” Working Paper, Sept. 12, 2007.
Mishkin, Frederic S. “Symposium on the Monetary Policy Transmission Mechanism.” The Journal of Economic Perspectives, Vol. 9, No. 4, Autumn 1995, pp. 3-10.
Rajan, Raghuram. “Bernanke Must End the Era of Ultra-low Rates.” Financial Times, July 29, 2010, p. 9.
Taylor, John B. “Housing and Monetary Policy.” A symposium in Jackson Hole, Wyo., sponsored by the Federal Reserve Bank of Kansas City (2007), pp. 463-76. See www.kansascityfed.org/PUBLICAT/SYMPOS/2007/PDF/Taylor_0415.pdf
4 things to do with your money now, while interest rates are low
It's a good time to be strategic about paying off debt. Maskot/Getty
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The Federal Reserve slashed interest rates yet again on October 30, marking the third rate cut since late July.
A lower federal funds rate essentially drops the earning potential on savings accounts, but makes borrowing money cheaper. Now is a good time to be strategic about paying off your debt and where you save your money.
Here are a few things you can do while interest rates are low:
1. Consolidate credit-card debt
When the Fed cuts its benchmark rate, borrowing money becomes cheaper.
It's never recommended to take on high-interest debt just because it's cheaper than it used to be, but if you're currently paying off credit-card debt and have ever considered consolidating it — i.e. taking out a personal loan at a lower rate and using the cash to pay off your balance — now is probably the right time to do it.
Federal Reserve data shows that borrowers who were charged interest on their credit-card debt paid an average of 16.97% in the third quarter of 2019, Credible's Matt Carter reported.
Meanwhile, the average rate on personal loans during that time was 10.07%.
That's the largest spread in more than 20 years of Federal Reserve records, Carter reported, making it a great time to take advantage of savings on interest.
Since consolidation requires taking out a personal loan, you'll still have a monthly debt payment to make but it will ly be less than your credit-card payments and your interest rate will be fixed. If you're juggling multiple credit-card balances, this can be a good strategy to streamline your monthly payments into a single bill.
Compare your options for a personal loan to consolidate your credit-card debt with Credible »
2. Refinance your mortgage
While mortgage rates aren't closely tied to the Federal funds rate, they are down since last year, making it a good time to consider refinancing to lock in a lower rate.
The interest rate on a 30-year fixed-rate mortgage averaged 3.78% as of October 31, compared to 4.83% one year ago, according to Freddie Mac. Average rates on 15-year fixed-rate mortgages are even lower at 3.19%, compared to 4.23% at this time last year.
Depending where you're at in the life of the loan, how much you owe, and whether you credit is in good shape, refinancing your mortgage could save a ton of money in interest payments and even help you pay off your mortgage early. Bear in mind that you will pay fees equal to about 2% to 4% of the principal loan amount to refinance.
LendingTree can help you compare options to refinance your mortgage »
3. Refinance your student loans
After hitting a post- recession peak last year, interest rates for student loan refinancing fell to a 12-month low in September, after the second Fed rate cut in as many months, Credible reported. If you're holding on to a high interest rate on your loans from college, it could be worth refinancing.
Student loan refinancing is when a private lender pays off your existing loan and gives you a new loan with a lower interest rate. You can refinance both federal and private student loans, but you'll lose benefits income-driven repayment if you refinance your federal loans.
You can refinance to today's lower rate and stick with it for the next several years through a fixed-rate loan, or go with a variable rate loan where the rate follows an index interest rate, such as the prime rate .
Keep in mind that in order to get the lowest possible interest rate, you generally need to have a very good or excellent credit score.
Credible can help you refinance your student loans to save money »
4. Open a high-yield savings account
Over the past three months, many high-yield account APYs have fallen from highs of over 2.5% to below 2%. But the rates on general savings accounts and checking accounts have dropped too, making them an even worse deal than usual. Right now, the average general savings account earns 0.09% in interest and most regular checking accounts earn 0.01%.
Lower interest rates may not be ideal for growing your savings right now, but there's still no better place to store money you need in the short-term than a high-yield savings account. These accounts keep your money safe from market risk and within arm's reach whether you're building up an emergency fund or saving for specific goals.
The best high-yield savings accounts still impose no monthly fees and have low minimum balance requirements. Plus, when interest rates inevitably go back up, you'll see a greater return on your money than if you started from scratch.
Smart moves to boost your savings even with low interest rates
If your bank has lowered rates on your savings account, don’t take it personally. It’s not you, it’s them. Interest rates have dropped across the board, and they’re ly to stay low for a while.
Yes, your savings may be earning smaller yields, but with a little time and attention, there are still ways to eke out growth.
Banks tend to lower or raise interest rates in response to actions from the Federal Reserve. The Fed, in turn, makes decisions economic conditions.
When the economy needs a boost, moves by the Fed generally cause rates to drop. Why? Interest rate decreases can encourage businesses and people to take out loans, increase spending and stimulate the economy.
(Rate increases in a strong economy, on the other hand, can help slow inflation.)
With the ongoing pandemic, the Fed has taken actions to stimulate the economy.
“The Federal Reserve’s latest economic forecast suggests that they will keep interest rates near zero, at least through 2023,” says Daniel Lee, a chartered financial analyst and certified financial planner in San Francisco.
Read: How saving $1,000 per year can make you a millionaire
This means savings rates are ly to stay lower for a few years. But it doesn’t mean your savings goals should be on pause.
You can still make smart money moves
Interest rates are just one part of your personal finance picture. It is also important to put away money regularly, regardless of the rate, so your cash cushion can grow. Once you’ve started saving, here’s what you can do to make the most of what you have.
Compare savings rates from other banks
The national average savings account interest rate is 0.05% APY. If your savings account earns more, you can consider it above average, even if it earns less than it did last year.
But you may still benefit from seeing what other financial institutions are offering. And if your rate is lower than average, you should absolutely shop around.
Some high-yield savings accounts and certificates of deposit, particularly those that are online-only, earn more than 10 times the average yield.
According to Lee, those are the accounts where you should be putting your money. “Not all savings yields are created equal,” he says. “You want to search for banks that are offering the best rates because every dollar counts.”
To see what other options are available, check out current high-interest savings accounts or high-yield CDs.
Whether you choose a savings account or CD ly depends on how often you plan to make withdrawals. You can generally transfer money savings accounts a few times a month without penalty.
With CDs, you usually agree to keep your deposit in the account for a set time frame — say, six months or up to five years.
In exchange, you might earn a slightly higher interest rate compared with savings accounts.
Eliminate existing bank fees
You can’t make your bank pay more interest, but you ly can stop it from charging you money. If your checking or savings account charges a monthly fee — often $5 or $10 a month — consider switching to an account that doesn’t.
You can also look for ways to get fees waived. For example, some banks let customers avoid maintenance charges if they sign up for direct deposit or maintain a certain minimum balance, typically around $500.
You can also keep tabs on your balance; this makes it easier to avoid overdrawing your account. Many institutions charge fees of $35 or more for each overdraft. If you have three in one day, your bank could slap a fee of more than $100 on your account.
By avoiding fees, you can probably keep more money than you would ever gain in interest, even if rates were higher.
Consider account sign-up bonuses
Some banks offer promotions to new customers who open an account and meet certain conditions. Qualifying accounts could receive bonuses of $100 or more. The conditions might include signing up for direct deposit, making a certain number of debit card purchases or maintaining a minimum balance for a few weeks.
If you’re thinking about switching banks — because your bank is charging one of the fees mentioned above, for example — consider moving to one that offers a bonus. If you qualify, the extra cash could more than make up for a relatively low interest rate.
Read next: Here are the average retirement savings by age: Is it enough?
Interest rates on bank accounts are at historic lows, and chances are they’ll remain relatively low for the next few years. But if you find the best rates possible and avoid high fees — and possibly snag a promotional perk — you’ll still be boosting your bank balance and securing your financial future.
More from NerdWallet:
- Your Mental Health Can Affect How You Save Money
- Are You Saving Money in the Right Place?
- Savings Accounts and CDs Are Still Worth It Despite Low Rates
As Interest Rates Plummet, Here’s How Savers Can Stay Above Water
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If there’s one thing personal finance experts can agree on, it’s the benefit of a high-yield savings account. They’re easy to open online with no fees, and can help grow your savings through interest earnings.
But circumstances are different this year.
In just a few months, following the coronavirus pandemic and ensuing recession, high-yield savings account rates have fallen from 10-year record highs above 2% to much more modest ranges. Many now hover between 0.70% and 1%.
In times of need, savings are a lifeline for many Americans, and even a partial emergency fund can make all the difference. But this year has also highlighted the ways in which a strategy reliant upon scoring the best interest rate may not be enough.
“The goal of a savings account isn’t to make money on the interest — that’s what investing is for,” says Ramit Sethi, New York Times bestselling author and founder of Iwillteachyoutoberich.com.
In fact, as savings rates continue to fall, experts say, the amount earned on a few thousand dollars in a savings account should be the least of concerns for Americans, especially those who are struggling most.
What’s Going On, Anyway?
Low interest rates are part of the Federal Reserve’s broader policy to keep the economy afloat, which is similar to the stance it took following the 2008 financial crisis.
During economic downturns, the people tend to save more of their money due to uncertainty, so low interest rates help get money into the economy as opposed to leaving it sitting in savings accounts. They spur business activity, promote consumer spending, and help businesses and consumers access low-interest loans.
At least in theory.
In reality, business activity is still slow, spending is down across various categories, and Americans are saving more than ever before.
“As long as people are afraid, as long as the U.S. is unstable, the virus is not contained, and the job situation is not under control, people will continue to save,” says Sarah Nadav, a behavioral economist and author of “What the F*ck Should I Do Now?” a guide to managing money in the time of COVID-19.
For some, a zero-bound, low interest rate environment may be inconvenient, but won’t have much impact. Those with stable income and assets can simply maintain their saving strategy without much regard to rates. They might even benefit from low rates as borrowers, by refinancing their mortgages at a lower rate or qualifying for lower-interest loans and credit lines.
But some experts, Nadav, are critical of how low interest rates can leave behind small savers: people without the means to take advantage of low-interest loans as borrowers who may be facing financial hardship.
On a broad scale, low interest can help avoid economic collapse — which is obviously beneficial for everyone — but that tradeoff comes at the expense of these individuals. Some accounts may no longer even keep up with inflation, over time.
“These low interest rates benefit people who have a lot of money,” Nadav says. “They don’t benefit the average small saver significantly.”
Small savers are also the least ly to benefit from low rates as borrowers. Tightened lending standards ensure that only those with the best credit scores will be able to access low-interest loans and lines of credit, so people already facing hardship will see little assistance from low rates on their credit cards or personal loan balances.
“You can expect that the average American, especially those who are already going through unemployment, will have a major hit to their credit score at some point,” Nadav says. “And once that happens, they’re not going to be able to take advantage of any of this. They’ll be locked out for the duration.”
So, What Can You Do?
For people facing severe hardship or persistent unemployment, frugality is not enough, especially as a second stimulus and extended unemployment benefits from Congress remain uncertain.
Now is the time to stop chasing pennies on interest rate earnings or relying on small budget changes that don’t make any real difference in the long run.
“I don’t want people to start making really intense decisions when they’re in debt and over their head,” Nadav says. “I’d rather they stand here now, look at what they have in the bank, and assume the worst so that they’ll be in the best position.”
Forget Interest, But Continue Saving
Your savings account’s interest rate isn’t going to get you ahead anytime soon, but don’t let that stop you from saving money.
Prioritize building your emergency fund, even if you can only contribute a few dollars each month. Choose an account that aligns with your long-term goals and focus on building your savings cushion to a place that you’re comfortable with.
In times of uncertainty, cash is king, Sethi says. He recommends aiming to cover one full year of expenses.
Even as they approach all-time low APYs, or annual percentage yields, a high-yield account with an online bank is still your best option. A relatively modest 0.80% interest rate is far better than the 0.05% national average, and when the Fed begins raising rates again, online banks will be among the first to follow.
Start Making Bigger Changes
Even if your situation isn’t dire — maybe you still have a couple months’ expenses in savings or you’re getting by on unemployment insurance — having a plan now can keep you from being left in a worse position later.
And that plan needs to go beyond small solutions cutting down on takeout and reducing your online shopping totals.
“That’s not helpful; it’s actually harmful,” Nadav says. “That perpetuates a level of denial where you can think, if I just cut down on these purchases and put money in my bank account, then I’ll be okay.”
Which substantial recurring expenses (think utility payments, auto loans, subscriptions) can you reduce or defer? What medical or nutrition assistance programs are you eligible for? Can you take on roommates or move in with a loved one to save on housing costs? Is there any available work you might qualify for, whether as a career change or temporary role?
Making these big-picture financial decisions can help you settle into a position today where you can at least maintain, rather than fall behind.
“One of the cardinal rules of personal finance is this: Live to fight another day,” Sethi says. “Do not put yourself in a situation where you’re forced to make decisions with your back against the wall.”
For those most affected by the pandemic, though, individual action is often not enough. Broader, extended economic stimulus — and a solution to today’s unemployment crisis — is necessary, Nadav says.
On top of the hit to any savings they might already have, those with the least amount of money coming in are still spending nearly as much as they were before the pandemic, despite record savings deposits overall.
A recent NextAdvisor survey found that the majority of unemployed Americans are using unemployment insurance simply to meet necessary expenses, with little left for saving — and that was before the extended $600 federal benefit expired in July.
“When people who need money get money directly into their accounts, they spend it,” Nadav says. “That stimulates the economy dollar-for-dollar or more. They’ll spend it, and they’ll often spend it locally. It’s a virtuous cycle.”
Looking Ahead: How Low Will Rates Go?
Federal Reserve officials predict today’s rates will remain through at least 2022, as the economy slowly recovers.
Since the federal funds rate — which banks use to determine the interest rates they set — dropped to a target range of 0% to 0.25%, interest on everything from mortgages to auto loans, credit cards and deposits has fallen in turn.
For someone with a $10,000 account balance, the difference between 2% interest in 2019 versus 0.80% today means a $120 yearly drop in interest earnings.
The only other time the Fed’s target rate fell this low was in late 2008, during the financial crisis.
“We’ve seen a collapse of rates much more severe than what we saw then,” says Ken Tumin, founder of DepositAccounts.com, a site that tracks deposit interest rates.
“When the Fed dropped to that zero bound, we didn’t see the bottoms of a lot of these online bank rates until about 2012 or 2013.
Compare that to this time; in a matter of months we’ve seen a lot of all-time lows at several of the online banks.”
Because banks have reacted much more quickly this time around, Tumin predicts rates will bottom out closer to 0.50%.
Light At the End of the Tunnel
Savers may not have to wait for the Fed to make moves in order to see positive action on their savings accounts, though. In 2013, some banks began raising rates again even as the Fed held low; and there’s reason to assume we may see similar moves this time.
If the economy experiences a rebound and people begin pulling some cash savings and putting it back into investments or increasing spending, for example, that could lead to banks increasing their rate offerings.
“I think that is something to hope for,” Tumin says, “even though it’s ly the Fed will hold rates at zero for several years.”