What Low Interest Rates Mean for Young Spenders and Savers

Interest rates these days could star in their own Flo Rida video: They hit the floor and next thing you know, they got low, low, low, low, low, low, low, low. With rates at already-record lows, the Federal Reserve promised in early August to hold short-term rates (to which credit card rates are tied) near zero at least through mid 2013. Then it enacted "Operation Twist" in late September -- a plan to lower long-term rates (which affect mortgage rates) by exchanging $400 billion worth of short-term debt for longer-term Treasuries.

How might crazy low rates affect you? Here are the answers to some questions you might have:

Will low interest rates take a bite out of my student loans?

Short answer: Probably not. There’s a good chance that your interest rates are fixed. Or that refinancing with your private lender won’t lock you into new ones.

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But don’t despair. A surefire way to reduce your federal rates right now is to sign up for automatic online payments at www.dl.ed.gov. That will cut your interest by 0.25%.

Borrowers with unconsolidated federal variable-rate loans (generally Stafford and PLUS loans issued before 2006) have the best opportunity to take advantage of lower rates. (Not sure which federal loans you have? Take a minute to check in again at www.dl.ed.gov.) For you select few, interest rates change annually on July 1 based on rates associated with U.S. Treasuries in late May and June, which are hovering at rock bottom. By consolidating your loans, you can lock in current interest rates before they inevitably rise.

Be aware, when you consolidate federal loans with different rates, that your new interest rate will be a weighted average, rounded up to the nearest eighth of a percentage point and capped at 8.25%. “Try to lock in at 5% or less, if possible,” says Deborah Fox, of Fox College Funding in San Diego, Cal. “That’s the median between the variable rates and the fixed rates.”

If your loans are more than five years old, though, odds are you’ve already consolidated. It’s generally considered good financial housekeeping to combine your student debt into one monthly payment. (See The Dark Side of Student Debt.)

Susannah says: I’m like many of you, dear readers. My outstanding federal loans are already consolidated into a single, fixed-rate plan. When I first started hacking away at my loans, I used the government’s Loan Consolidation calculator to weigh my options and choose a new repayment plan. I have peace of mind knowing that my interest rate won’t rise and that my monthly bill is manageable. I just can’t take advantage of lower interest rates. Le Sigh.

Private borrowers who have variable interest rates can also look into consolidation (you can’t combine private and federal loans, however). But private student loan consolidations are decided on a case-by-case basis. Some private lenders, such as Chase Bank, have slammed the door on student loan consolidations because they are no longer profitable. Sallie Mae has also temporarily suspended its private consolidation loan program. And even if you can consolidate, your loan may still carry a variable interest rate, so you won’t necessarily hang onto lower rates. Contact your lender to see what’s available, or shop around. Fox recommends looking into credit unions, if you’re eligible. They tend to offer better rates, she says.

Unlike federal borrowers, whose rates are determined by outside economic factors, you may be able to get your private lender to reduce your rates regardless of the general economic climate. Look into getting a lower rate based on an improved credit score or newly increased salary.

Don’t have an existing student loan -- yet? Favor federal over private loans, if you’re planning to attend graduate school. Corporate lenders generally don’t offer benefits such as deferment, loan forgiveness or extended repayment plans. Next year’s interest rates for federal graduate Stafford loans will hold steady at 6.8%.

Should I buy a house now to snap up these low mortgage rates?

You may want to take advantage of the spectacularly low mortgage rates available right now: According to Bankrate.com, the benchmark 30-year fixed-rate mortgage dropped from 4.5% to 4.29% over the past year. Plus, the low demand and high supply of housing is currently favoring buyers. Kiplinger’s expects housing prices to stay low for the rest of the year and through 2012. And you could even benefit from a little schadenfreude and snag a foreclosure or short sale at a deep discount. (See 6 Good Reasons to Buy a Home Now.)

But all these advantages shouldn’t rush you into such a huge commitment. We all need to learn a lesson from the multitude of distressed sellers out there, and be sure we’re really ready for homeownership.

Stacy says: My husband and I, for example, are slowly starting to shop -- taking our sweet time touring neighborhoods, figuring out what we value most in a potential home and asking ourselves these five questions, including, “Are your financial ducks in a row?”

To answer, you’ll need to figure out your credit score and how much you can afford for a down payment and your future monthly payments. With lenders being stingy, you’ll need a credit score of at least 740 and a minimum 25% down payment to snag the lowest rates. According to MyFico.com, with a score between 660 and 679, you’ll pay 4.4%, or $1,503 a month, for a $300,000, 30-year fixed-rate mortgage. But with a credit score of 760 or higher, you’ll pay just 3.79%, or $1,396 a month, for the same loan.

If your finances need a tune-up, you have some time. “Mortgage rates are probably going to stay low over the next several months, if not the next couple of years,” says Gerri Detweiler of Credit.com. Take this time to boost your credit score and build up your down payment. “But rates are very volatile and can change within hours,” says Detweiler. “So if you’re ready and can qualify to buy, go ahead and get a good rate now rather than speculate on what could happen in the future.”

What’s going to happen with my credit card rates?

Not much, for now. Most credit cards have variable interest rates that are tied to the prime rate, which the Federal Reserve promises to keep near zero until at least mid 2013. After that, rates are likely “to creep back up again and start to look very unattractive,” says Detweiler. So you should attack credit-card debt now, while rates are still low.

If you’re hoping to get a first or new credit card, you’re going to face some challenges. “There is a legitimate concern that lenders may tighten up on credit lines and on approvals,” says Detweiler. “It may be especially difficult for younger people to get that start and establish the kind of credit rating they need to get the best rates.”

The no-credit life has plenty of plusses (see The Case for Cutting Out Credit Cards Completely), but if you want -- and can responsibly handle -- a card to help build your credit history, try shopping on Credit.com or Bankrate.com. Credit newbies will want to look for types of cards that are easier to get, which -- warning! -- means they’ll also usually come with higher interest rates. You can search either site for student cards (see our slide show: 6 Student Credit Cards That Make the Grade), cards for bad credit, prepaid cards or secured cards (which require a savings deposit equal to your credit line). Bankrate also allows you to browse and compare retail credit cards, while Credit.com lets you search cards by credit score, including cards best for those with limited or no credit history.

Aim for a rate of 15% or less, says Detweiler, and watch out for annual fees and hidden costs. But understand that you’ll need a high credit score to nab the lowest rates. If you can’t score a great rate now, work on boosting your credit score and “periodically -- once every year or two -- check to see if you qualify for a better rate as your credit gets stronger,” she says.

Where should I stash my savings?

Low interest rates make it harder for young savers to hold onto cash and still beat inflation. Like everyone else, we bright-eyed, bushy-tailed young savers should aim to squirrel away at least three to six months of living expenses in an emergency fund, an account that we can access at the drop of a hat in case of a medical emergency, layoff or other unexpected expense. And never underestimate the power of a cash cushion. “The more you save, the less you borrow, and the better-positioned you are to take advantage of the future,” says Erin Baehr, of Baehr Family Financial, with offices in Stroudsburg, Pa., and Randolph, N.J.

Resist the siren call of higher yields promised by investments such as long-term CDs or mutual funds, which would lock away your cash so you couldn’t quickly and easily access it. Baehr recommends saving your rainy day fund in a “high-yield” online bank account. For example, American Express Bank’s FDIC-insured savings account yields 1.0% as of late September, with no required minimum or monthly fees. At Bankrate.com, you can compare the rates on tons of savings accounts and select the one that best fits your needs.

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