How Lowering Interest Rates Helps Someone
Lowering interest rates makes it less expensive to borrow money. Paying less interest reduces monthly bill payments and improves borrowers' overall cash flow. The government can lower interest rates by lowering the cost of lending for financial institutions because lenders usually pass on rate cuts to consumers. You can also lower your rate by refinancing existing loans to lower-rate loans.
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Monthly Payment
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Term loans, such as fixed-rate mortgages and car loans, are amortizing loans. Amortization involves the lender calculating the total principal and interest owed by the borrower and dividing that total into equal monthly payments. Your payments are therefore comprised of both principal and interest so if you refinance to a low-rate loan, you reduce your monthly loan payment. If you reduce your monthly payment by $50, for example, you save $6,000 over the course of 10 years.
Terms
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Mortgages tend to have standard terms of 15 or 30 years but you can take out automobile loans and home equity loans with terms of various lengths. Many people use the payment as the determining factor for their terms. If you can afford a payment of $350 a month, ask your lender to ensure your monthly payments do not exceed that amount. However, if you can borrow at a lower rate of interest you can pay your car off more quickly. Even though your monthly payment stays the same, you can reduce the term because of the interest savings.
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Debt-To-Income Ratio
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Potential lenders examine your debt-to-income ratio. Your DTI consists of your monthly debt payment divided into your gross monthly income. You may not qualify for a new loan if your current DTI ratio exceeds 40 or 50 percent. However, if you can reduce the interest rate on your credit card, car loan or mortgage, you reduce your monthly debt and therefore lower your overall DTI. This makes it easier for you to qualify for new loans.
Other Considerations
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When a lender lowers your interest rate, your monthly cash flow improves and you can pay off your loan more quickly. However, if you refinance a car or a home you must pay closing costs. And if you transfer a balance from a credit card to another card with a lower rate, you normally pay a balance transfer fee. Consider these upfront costs as well as long-term savings to determine whether you will benefit from refinancing or from moving your existing debt to a credit card with a lower interest rate.
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References
- Federal Reserve Bank of St. Louis: "Low Interest Rates Have Benefits ... and Costs"; Kevin L Kliesen; October 2010
- U.S. News and World Report Money: "Five Ways to Take Advantage of Low Interest Rates"; November 2010
- Smart Money: "Top Five Ways to Take Advantage of Lower Interest Rates"; Anna Maria Andriotis; April 2008
