Ever since the mortgage-backed security debacle triggered the great recession, the Federal Reserve has been aggressively implementing monetary stimulus policies.
The Fed's bond buying programs, known as quantitative easing, have boosted the money supply, provided liquidity and helped hold interest rates low. Cheap money is intended to spur investment, get the economy growing and accelerate the growth rate. Growth should help reduce unemployment.
A saying that's been around for years goes something like: High on the intellectual list, we find the great economist. Who seven days a week advises, capitulates and analyzes. When things are high, he likes to show the reasons why they should be low. When they are low he can decry, the reasons why they should be high. Knowing that time in constant flight eventually will prove him right, he'll say, "I told you all along, economists are never wrong."
Expect interest rates to rise
Now, while interest rates are low, the economist is about to decry why they should be high.
Fear of inflation is one reason. In the late 1960s and early 1970s farmers learned they could borrow single-digit interest rate money and buy farmland that was appreciating at double-digit rates. Farmers, and others, developed a "Buy it now because it will be worth more next year" mentality. Does that sound familiar? Their actions became seemingly self-fulfilling prophesies, fueling inflation.
Accelerating inflation, however, soon became public economic enemy number one. The Fed ultimately clamped down hard on money supply growth to rein in inflation. Interest rates skyrocketed. Farmers who had variable interest rates loans faced great financial pain as debt-service requirements surged, while land values fell.
Another reason is a big supply of anything makes it cheaper. Dollars are no different. When more dollars begin chasing the same amount of goods, it takes more dollars to buy those goods. When our dollar declines in value, interest rates rise to maintain a relative rate of return.
A big money supply also makes our dollars cheaper relative to other foreign currencies. Relative currency exchange rates can promote trade, or hinder it.
In May 2013 Fed Chairman Ben Bernanke hinted the Fed could begin to roll back quantitative easing late this year. Many investors had been expecting QE to continue well into 2014.
Time will eventually prove the economist right. Interest rates will get high. You want to lock in as much of your debt as possible at fixed interest rates that are lower than those ahead.
How high could rates go?
For perspective, the fight against inflation of the early 1980s drove the prime interest rate to 20% and the 30-year fixed rate mortgage interest rate to 18%.
Those figures, and history, suggest one need not be a great economist to conclude that interest rates have more upside, than downside, from current levels. Whether we'll soon be facing conditions that could be as extreme as those of the 1980s is a matter of considerable debate.
Planning your financing strategy
For perspective, some adjustable rate mortgages have the interest rate set near 2.5% for the first five years. That might look like a better deal than a 15-year fixed rate mortgage at around 3% or a 30-year fixed rate mortgage at around 4%.
The first question is how much longer do you expect to be in debt? If you'll pay off your current variable interest rate loan before the reset date, you, in effect, have a fixed interest rate loan. But if you'll be debt for longer than the reset, start pushing your pencil.
Over time, interest rates rise and fall. Depending on their trend and your appetite for debt, shifting from fixed-rate to variable-rate loans can make sense. Of late, the variable interest rate route was usually the best in terms of profitability. Going forward, that does not appear to be the case.
Now may be the time to shift gears and add some stability to your financing costs and take worries about interest rates off the table. You have better things to worry about.