Low Interest Rates and You: How to make it Work to your Advantage

Low interest rates are enticing, exciting, and, in many ways, a necessary component in economic recovery. They make everything seem like a good deal. In response, consumers are goaded into spending more; this is, after all, the entire purpose behind the Federal Reserve artificially lowering interest rates. However, sometimes that can be a bad thing, for the consumer anyway.

It may seem odd referring to lower interest rates and reduced cost of credit as a “bad thing” but the problem is in the way most consumers treat low interest rates:

1. PRE-APPROVAL: The problem starts with pre-approval. When credit terms are more favorable, consumers are typically approved for more that they would be in times of less favorable terms. While this can work to your advantage if you take on a fixed-rate mortgage, if you take on an adjustable-rate mortgage (ARM) and rates adjust by as little as 1.5 percent, your monthly payments could shift by several hundred dollars per month.

2. ADJUSTABLE RATE: While this could, of course, happen at any time with an ARM, when you get pre-approved during times of better credit terms and you get approved for a higher amount, the risk that your ARM will adjust to a rate outside of an affordable range is greater. For instance, let’s say you are approved for $355,000 at 4.5 percent interest. This means that your payments would be approximately $1,800, whereas had you been approved at 6 percent, the going rate for the last few years, you probably would have been approved for only $300,000 because at 6 percent, your monthly payment would be the same as $355,000 at 4.5 percent ($1,800).

3. SHOPPING FOR A HOME: Moreover, most consumers focus their home search based on the pre-approval amount, even looking for homes with prices slightly above the pre-approval amount (e.g. approved for $355,000 and looking for homes in a price range up to $400,000). While this means that you can get more home for your monthly payment, the problem is that most consumers spend the full amount of their pre-approval amount and end up with the associated costs of a higher priced home (e.g. increased insurance rates, higher closing costs, higher taxes).

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