Interest Rates, Time, Personal Finance, and the U.S. Treasury
8/3/2005
It seems U.S. Treasury officials have spent the past four years asleep at the switch, only to be awoken from their slumber last week with the apparently startling news that the federal government has been running a massive budget deficit in each of its past four fiscal years. What to do, what to do? Largely responsible for financing the continuing operations of government, Treasury needed a plan to better cope with our burgeoning debt and opted to begin re-issuing the 30 year Treasury bond. It’s about time, particularly given our current interest rate environment.
Even the greenest financiers recognize the value and prudence of borrowing money at historically low rates for as long as possible, while lending for as short a period at which a competitive rate is available. This immutable premise however, like most expenses where the taxpayer is footing the bill, was largely lost on government for nearly half a decade. Given that federal deficits have been, and continue to be, expected well into the future, we should all thank John Snow for endorsing a government action that actually makes sense to taxpayers of all generations.
While on the subject of interest rates, it is essential for the financial well-being of the typical American that they too understand how changes to the interest rate environment could adversely affect them over the intermediate and long-terms. This is particularly poignant with respect to mortgages and credit cards. As a society evermore dependent upon debt to finance lifestyle, many acquisitions are made based upon expectations of a certain monthly payment rather than upon the debt actually accumulated. Unfortunately for many, these expected payments could rise dramatically if the rate at which money is borrowed is not fixed, putting one’s financial health at serious risk. This applies to those who have adjustable rate mortgages, known as ARMs, as well as virtually all holders of credit card debt.
ARMs offer home owners the opportunity to borrow money at a rate below that of most fixed mortgages for a specific period of time. However, after said guaranteed period expires the associated interest rate can fluctuate, typically as much as 2 full percentage points. For those who plan to remain in a home for longer than that of the “fixed” guarantee, higher interest rates will most certainly spell higher payments making that which was once affordable unaffordable to many. This has the potential of not only spelling financial hardship for those who are caught in such a quandary, but could also adversely affect real estate prices and in turn the economy as a whole. Given these near certainties, I would highly encourage those financing or re-financing real property to choose a fixed option over alternatives. In other words, borrow for as long a period as possible with defined terms while rates are low.
Much the same can be said of credit cards. Higher interest rates in the broad market will force (or allow) credit card companies to increase the rate they charge. Higher rates will force those who have borrowed to pay higher minimum payments to credit card companies using cash flow that many depend on to service other financial obligations. Faced with an inability to make some payments, many consumers will forgo payments to some creditors, negatively impacting both their ability to get new loans under favorable terms to make good on previous obligations, commonly referred to as “robbing Peter to pay Paul”, as well as creating penalties in addition to the higher interest rates. Unfortunately this route is all too often taken and it is the road to financial ruin.
Some, I know, are not prone to the behavior of which I speak, and I congratulate your discipline. For the rest, please, for your own sake, heed the warning, not from me, but the U.S. Treasury.
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