December 2006 Topic - "Interest Rates"

01.  What are interest rates and how they work?
02.  When to take advantage of interest rates
03.  Questions and Answers

1.A little History | What are interest rates and how they work?

Alan Greenspan was the Chairman of the Board of the Governors of the Federal Reserve from 1987 until 2006. He received the honor from Ronald Regan in 1987 and was the first appointed. He was re-appointed at 4 year intervals until he retired on January 31,2006. He relinquished the honor to Ben Bernanke. Ben Bernanke previously was Chairman of the Board of the U.S Presidents Council of Economic Advisors. Prior to taking his federal position he worked for Goldman Sachs, which is one of the world's largest banking firms. He is a self made millionaire therefore did not take this position for the money.

President George W. Bush swore him in on February 1, 2006. His term will expire on October 4, 2009 at which time he can be reelected. His daily tasks include many different things. The most imperative is to keep our economy afloat. He is the man who has the final word on whether interest rates go up or down. He tries to keep the economy from going into inflation or recession. His goal is to grow the economy and keep Americans employed.

The decisions that he makes affect everyone globally, since the US money is recognized in all economies. Once he decides to lower or higher an interest rate all banks must adjust to that. The reason that this affects everyone is because the interest rates affect your mortgages, credit cards, car loans, savings accounts, and much more. This not only affects the mortgage business, but also the construction businesses that build homes or other properties. You see if the interest rates go up there will be less potential buyers, which will result in less work demand. It will also affect the cost of supplies and the availability of construction financing.

Most people have heard the terms "interest rates are down or up", however not many people realize what determines that. There are many factors that make the interest rates rise or fall. The Federal Reserve also referred to as Fed is in charge with maintaining the stability of this nation's economy. Another tool that the Fed uses is based around issuing treasury bills. The way this works is to issue new treasury bills to add more money to the economy. It works to take money out of the economy by buying back treasury bills.

Interest rates change periodically to maintain financial stability. To prevent inflation short term rates are increased. In 2006 alone interest rates were raised 17 times! The Fed does this to slow down the economy. Higher interest rates result in less money being borrowed. On the flip side, the Fed will lower interest rates when the economy is slower. Then the cost of borrowing money is lower so more people and businesses will spend more money, which boosts the economy. This must be done to prevent recession.

There are many different areas that the Fed take into account when deciding to lower or raise the interest rates. For example unemployment rates, new home construction, and consumer confidence index. Other factors that affect interest rates are taxes, profit and government. Interest can be increased to compensate for earnings that are subject to taxation. It does not happen often but is possible for a bank to add to the interest rate to gain profit. Finally, the government often times affects the interest rates by selling or buying securities.

2. When to take advantage of interest rates

When interest rates are lower they will work to your benefit if you are borrowing money. On the other hand, if you are planning to save money you want rates to go up. On the other hand rates rising will help your savings account but you will pay more to borrow money. You will find there are pros and cons to each. The question is how to make it work for you. Unfortunately not many of us know our futures. We cannot predict when we will have money to save or when we will need money to borrow. However what we can do is try to have a goal or plan of action that we hope to take.

Planning is the key to making the market work in your favor. It is the end of the year and this is when you should plan for next year. The best way to do that is to figure out what you did with your money last year. Take out all of your credit card statements and bank statements. I know you are probably laughing right now and thinking I am crazy but it works. Add up all your debt from this year and compare it to last year's debt. Try to figure out how much debt you paid off and how much you still carry. Find out what your interest rates are on your debt that you are still carrying.

Pay off the high rate cards first. Try to negotiate with your creditors to lower your rates. Believe it or not often times they will. Credit card companies will usually lower your interest rate if you ask. Sometimes you will have to speak with a manager and just explain that you are interested in finding out if your interest rate can be lowered. Even just a couple of points will make a difference. It is always worth a try the worst scenario is they decline your request.

Mortgage rates raise and fall often times throughout the year. Take advantage of the falls in interest rates by refinancing your property. You will want to do your homework first though. Other costs come into play when refinancing. You must consider closing costs, PMI, and title costs. After adding them up you will see if lowering your interest rate by refinancing is best for your situation.

Many people refinance into a locked rate when interest rates are low and they end up saving a lot of money throughout the year. You can also make the market work in your favor when interest rates are high. Remember interest rates affect savings accounts also. People on a fixed income, like retiree's get hit hard in this area.

Sometimes their only source of income is based on bonds and if the interest rates drop drastically so does their monthly income. Whereas if the interest rates go up so does their income. The higher the interest rate the more money you are receiving. Check out a variety of financial institutions because they often compete and you may receive more interest from one institution than another

There are risks in borrowing money. It seems like a simple process when defined. You borrow money and pay the lender back, however it is much more complicated. You must remember all the risks associated. Below are the most common risks.


• Default Risk: The risk of non-payment.
• Interest Rate Risk: The uncertain changes in the market.
• Liquidity Risk: The ability to sell an asset. If an asset can be sold for fair value it is considered highly liquid. In other words there are many interested buyers. Whereas when an item is harder to liquidate or sell it is considered an illiquid asset.
• Inflation Risk: When the economy rises the asset loses it values.

3. Questions and Answers

What is interest? Interest is the amount of money you pay for borrowing money.

What is recession? Recession is when money is not being spent on products and services. Businesses cannot stay afloat and employees lose their income.

What are the different types of interest? Fixed rate: It is a guarantee that your interest rate will not change regardless of the market.

Variable rate Your rate can be change depending on the market and the base rate set by the Federal Reserve.

Capped Rate: This is where the interest rate has been set at a level and even if the base is raised the interest rate is capped.

How can I find out what the current federal funds rate is? It is always available on the Board of Governors website.

Where can I find out the current interest rate? You can find out the interest rates on the Federal Reserve Discount Window website.

Is the interest paid to the IRS deductible? No, the interest paid the IRS is not deductible.

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Got a question? Then contact our Education Team on 561-883-2398 Ex.310 United conducts regular seminars on financial education, including "How to Budget", come along and join us. To reserve your seat contact our Education Team on 561-883-2398 Ex.310

Newsletter 12
Rev.1
December, 2006