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How to Weather Interest Rates

How to Weather Interest Rates

Interest rates define the cost of money and, much like any other commodity, they react to supply-and-demand economic pressures.
 
When people are earning less, they look to borrow more, and interest rates rise. High-interest loans also reduce the opportunity and affordability of business expansion. To further compound the economic situation, people with disposable income often choose to increase their savings to enjoy higher interest returns instead of spending money. These ripple effects slow the macroeconomy and undermine investor confidence.
 
How are interest rates established and by whom? The Federal Open Market Committee (FOMC) meets regularly eight times a year to adjust the fed funds rate, as needed, to maintain a stable but growing economy. This is the rate financial institutions use to lend money to other financial institutions. As it fluctuates, so will the rate that financial institutions can afford to offer their clients or members, a.k.a. you. According to thebalance.com, adjustments can take 12 to 18 months for the shift to be realized, so FOMC members need to be forecasting experts.
 
Most people have heard of the prime rate. This rate, however, isn’t the same as the fed funds rate. The prime rate refers to the rates that individual financial institutions set. These rates are always a bit higher (approximately 3%) than the fed funds rate. While it isn’t set by the FOMC, it’s definitely tied to the oscillation of the fed funds rate. Borrowers will pay prime rate, plus additional percentage points for a loan. In the U.S., this rate reached an all-time high of 21.50% on December 19, 1980, while its mean over the past 30 years has been 6.84%. The current prime rate has been cut as of October 31, 2019 and is now 4.75%. The prime rate will continually rise and fall, and while it’s a bit lower now, you can be sure it will rise again.
 
Here’s what you can do to be ready:
  • Provide customers with another way to save. It only makes sense that when interest rates are high, saving is up and spending is down. That means your customers are also spending less. In order to entice them to buy during times of high interest rates, you need to make it worth their while. Consider offering a limited-time BOGO or a “buy more, save more” sale.
  • Lock in a fixed-rate loan. While the current prime rate is low, it has been slowly inching upward from 3.25% since December 2008. Now is a good time to lock in a fixed-rate loan. This will protect you from borrowing when rates are higher.
  • Move savings into a higher-yield certificate. High interest rates obviously provide opportunities to earn more by saving. Find ways for your money to work harder, such as moving savings into a higher-yield, more profitable certificate when rates are high.
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