Over the past couple of years, many of us have heard more about interest rates than we probably ever expected to. Indeed, whether you’ve tried to buy real estate, get a car loan, or pay off credit cards, there’s a good chance that you’ve noticed that interest rates have increased dramatically since 2022. On the positive side, if you have a high-yield savings account, you might have noticed that your returns on those savings accounts have gone way up.
These changes were fast and dramatic and I’ll discuss a bit why they happened. However, all of a sudden, things seem to be changing in the opposite direction. In many areas, interest rates are coming down or stabilizing. What do these changes mean for our financial plan? Should we be making any changes ourselves? Or should we stay the course?
In this post, I’ll go over what interest rates have been doing and what economists expect them to do going forward. I’ll then discuss what this might mean for your financial plan, including saving, paying off debt, and buying real estate. By the end, I hope you feel more confident about making a financial plan that works for you and your adulting goals.
Why Did Interest Rates Get So High?
Over the past couple of years, interest rates have changed dramatically. Indeed, from 2020 to early 2022 interest rates were at some of their lowest levels. As a result, borrowing money was cheap. That, combined with repressed spending during the COVID shutdowns meant that people started going on spending sprees. This spike in demand was one factor that led to high inflation. Businesses found they could raise prices without demand decreasing much.
Because of skyrocketing inflation, the Federal Reserve started raising rates. The Federal Reserve sets the federal funds rate, which is the interest rate at which banks can trade excess funds with one another. This is also considered a benchmark interest rate because it influences interest rates in many sectors. Consequently, Fed rate hikes lead to higher interest rates on everything from mortgages to credit cards.
The idea is that higher rates on interest should lead to lower demand because borrowing money becomes more expensive. As a result, people will buy less and prices will come down. Unfortunately, that process takes a long time and it’s super difficult. Even with prices increasing, many people still went on trips, bought cars, ate out, and racked up debt because their spending felt so repressed during COVID. Luckily, these interest rate changes have actually been working better than they have throughout most of history. As a result, inflation is coming down.
Why Are Interest Rates Declining?
In recent months, however, we’ve seen inflation stabilize and come down. As a result, the Central Bank has not issued a rate increase in awhile. That’s meant that things like mortgage rates have stopped increasing and are even decreasing slightly (though not as much as many people would like).
In the coming months, economists expect the Fed will issue a lower rate for debt. In the long term, that likely means that interest rates will decrease in a wide variety of areas.
That being said, no one expects rate cuts to the level of what we saw during COVID. So don’t base your financial plan on super low interest rates. Economics expect that mortgage rates will eventually come down to 5%, though that may still be years away. Instead, you can anticipate modestly lower interest rates on mortgages, credit card debt, car loans, and high-yield savings accounts. You can also expect lower levels of inflation compared to what we’ve experienced recently.
What Do Low Interest Rates Mean for My Spending and Debt?
One of the biggest benefits of lower interest rates is that it generally translates to lower credit card rates. Low rates mean that you waste less money on interest and the cost of debt is lower. That being said, there’s often a big lag between when the benchmark interest rate decreases and the interest rates on credit cards decrease. Indeed, it’s in the best interest of your credit card issuer to take their time decreasing interest rates.
Aside from credit cards, this also means that interest rates go down on other types of loans such as car loans and home equity lines of credit. It’s tempting in these situations to take on more debt. However, it’s important to resist the urge to buy non-needed purchases and instead divert cost savings from lower interest rates to paying down debt. Your credit score and budget will thank you!
Moreover, if you are paying high rates on interest even as the average rate has come down, you may want to call your lender and ask about the lowest rate they can give you. You can also consider consolidating your debt into a lower interest loan. Keep in mind, however, that this should not be used as an opportunity to take on more debt. Rather, it’s an opportunity to pay down debt faster.
What Do Low Interest Rates Mean for My Saving Plan?
As noted above, lower interest rates can enable you to pay off debt faster. This is one way that lower interest rates can actually help your long run savings. Once you pay off debt, you can divert the money you were paying on your debt to your savings and long-term goals.
Changes in interest rates can sometimes affect stock prices as well. It’s important to note that stock market returns are never guaranteed. However, in the past, interest rate decreases have tended to correspond with periods of economic growth. Just like debt costs less for us regular people, it costs less for businesses too. So businesses can invest, grow, hire people, etc. When this happens, stock prices often increase. This, in turn, can improve your retirement and other long-term savings. Consequently, you may find it beneficial to continue or even increase your investments. However, talk with a financial advisor before making any changes!
Finally, there is a downside of lower interest rates for savings. In general, lower interest rates on debt mean lower interest rates on savings accounts like high-yield savings accounts and fixed income investments like CDs, money market accounts, etc. As a result, this can be a hit to your savings if you have a lot of money saved or invested in these areas.
What Do Low Interest Rates Mean for the Housing Market?
When it comes to interest rates, many of us are especially interested in how mortgage interest rates might change in the next year. After all, home prices are at a record high. Plus, in 2023, 30-year mortgage rates reached their highest level since 2001. This combo of high mortgage rates and home prices has meant that many people (myself included) have been shut out of the housing market.
Luckily, we’ve seen lower mortgage rates in recent months. Economists anticipate that 30-year fixed-rate mortgage interest rates will continue to come down over the next couple of years. That being said, experts’ guesses are that 30-year mortgage rates will decrease to 6-6.5% in 2024 and stabilize around 5% in the long term. Plus, pent up demand for home sales means that as soon as interest rates come down, prices are likely to rise again. Consequently, it’s hard to say how beneficial lower interest rates will actually be for people who want to buy a house.
If you have an adjustable-rate mortgage, on the other hand, lower interest rates will likely come as a relief. And if you’re debating between a fixed rate and adjustable-rate mortgage, remember that few financial advisors recommend adjustable-rate mortgages. Their unpredictability often makes them bad for financial planning and a worse overall deal than a fixed rate mortgage. A mortgage lender and certified financial planner can help you better understand your options.
What Do Low Interest Rates Mean for My Long-Term Plan?
So what does all this mean for your long-term plan? So far we’ve discussed that lower interest rates generally mean that the cost of credit cards, car loans, mortgage payments, and more are lower. Additionally, lower interest rates are sometimes associated with improvements in the stock market. However, interest rates on savings accounts generally come down as well.
Overall, this can help you achieve your long-term goals. You might use extra money from lower debt payments and inflation to pay down your debt or save towards long-term goals like a down payment or retirement.
If your long-term plan involves buying a home, this is also a good time to run your numbers. Use some of the online housing calculators to figure out how much home you can afford based on the current rate and average prices. You can use this information to gauge whether you need to wait for interest rates to come down more or save more for a down payment to get the kind of house you want. Running your numbers is the best way to tell whether you’re financially ready to buy a home. Headlines and influencers can’t do that for you.
What If I Don’t Have a Long-Term Plan?
You might notice that these recommendations all assume that you have a long-term plan in place. They don’t actually involve changing your long-term plan. The reason for that is that the best strategy is one that will serve you in the long-term. This strategy should outline your long-term goals and how you want to save for them.
For example, in your plan you might specify the percentage or amount of your income you want to invest each month for retirement. Or you might have a goal amount to save for a down payment and how much you plan to save each month to get there. Low interest rates can make it a little easier or harder to work towards those goals. However, they shouldn’t change the goals themselves. Timing the stock market or housing market is nearly impossible. What works better is to have a long-term plan and stick to it.
For me, I have long-term goals that tell me how much to save and invest each month for retirement and a down payment on a house. I won’t be changing those. However, if I have extra money, I will funnel part of that to maxing out my Roth IRA and part of that to saving for a down payment in a high yield savings account.
Consequently, start with a long-term plan. Outline your goals and how you’ll work to get there. And if your goals have you buying a house, paying down debt, saving for retirement, etc., assess how lower interest rates might play into or accelerate those goals. A certified financial planner can help you do this.
Final Thoughts on Interest Rate Declines
Many of us have been financially strained over the past couple years as inflation has risen and interest rates have risen with them. The good news is that interest rates are likely to come down in 2024 and 2025.
For many of us, this can improve our financial situation. Lower interest rates mean lower costs on debt and can sometimes mean a better stock market. As a result, you may find that you have more money to pay down debt and/or save towards your goals. The key is to have a financial plan that outlines those goals. Defining your goals can prevent you from spending money on more meaningless things or getting swept up in FOMO and making financial decisions that are not good for the long term.
Remember that I am not a certified financial planner. A certified financial planner can help you develop your financial plan and make financial decisions. This article is solely for informational and entertainment purposes. Before making any financial changes, you should speak to a professional.
If you enjoyed this post, please consider liking, subscribing, or sharing with others. It’s always a big help. If you’re interested in related content, check out my posts on saving printables and guide, prioritizing multiple savings goals, developing a budget, free budget planners for kids, and more in the personal finance section of my blog.
