Interest and dividend rates may seem to change at a whim. Unless you happen to be chairperson of the Federal Reserve Bank, you can’t do much to control which direction the credit cycle takes. But if you understand a bit about why these rates change, you can time some important financial decisions to your advantage.
Low interest rates mean lower loan payments, and high interest rates mean higher dividends earned on deposit accounts. So how do you know when it’s the best time to borrow or save?
Money’s changing moods
Interest and dividend rates reflect the cost of borrowing money. As with most prices, supply and demand play a big role. In a growing economy, more businesses and consumers want to borrow money, pushing interest and dividend rates up. On the other hand, businesses and consumers scale back purchases in a slow economy and take on less debt. Demand for borrowed money goes down, and interest and dividend rates follow.
A great example of this phenomenon is the U.S. mortgage market within the last five years. Interest rates for mortgages have hit historic lows, and right alongside these rates, the dividend payments on basic savings and money market accounts dropped too.
You’ll also notice the credit cycle at work when lending institutions get more discriminating about who qualifies for loans. “Depending on the cycles, a consumer may be able to obtain a loan very easily, or it may be challenging for them,” says Julie Bruning, Vice President of Consumer Lending at SAC FCU.
Much of the 2008 financial downturn stemmed from financial institutions approving mortgage loans to people who couldn’t make the payments. Because many complex investments were tied to the mortgages, their failure triggered big trouble in the stock market. A residual result was that lenders started taking a harder look at loan applicants and required bigger down payments, making it more difficult to get approved for a mortgage loan.
What you can do
Economics lessons aside, what you really care about is how you can act wisely in relation to the credit cycle.
One obvious way is to take advantage of low interest rates on loans like those in the market right now. “It is a great time to purchase a home or do any home renovations due to the low interest rates,” Bruning says. “Auto and personal loans also have very low rates.”
Now that lenders are more selective about who qualifies for loans, it’s also important to maintain a healthy credit rating.
- Manage debt wisely. Maxing out a credit card can negatively impact your credit rating.
- Stay on top of payments. One missed payment may not only result in fees, but can also lower your credit score.
- Be selective about credit products.Opening too many new accounts can put you in a bad financial position.
A healthy credit rating allows you to expect the best interest rates available, and that can save you quite a bit of money in the long run.
Watch the cycle
When the time comes to apply for new credit, shop around for the best rate and pay attention to the direction the credit cycle takes. Knowing how the credit cycle drives rate changes allows you to make smart choices when it comes to your money.
Have you used the credit cycle to your advantage? Share your tips in the comments.
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