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How the low mortgage interest rate in the US effects the economy

Date January 18, 2017

How the low mortgage interest rate in the US effects the economy

This year has seen a drop in mortgage rates in the first and second quarter to below those last seen in 2013.  This decline has seen a burst of new mortgages resulting in a boom in the banking sector.  Not only were there a massive increase in new mortgage bonds, but existing mortgage holders have made use of the lower cost of loans to lock in better rates over the long term.    It currently appears that this trend will stay firm for the 3rd quarter, possibly resulting in a massive increase in mortgage bonds for the year overall.

The interest rates had been expected to increase in the 2nd quarter, which should have resulted in a decrease in the refinance market but for profits on loans to increase to financial institutions in the US over this time frame.  The cost of funding has also increased dramatically this year, which results in a much smaller profit margin to the banks and loan companies.  This may prove unsustainable if this trend continues as the margins may eventually become too small for it to be worthwhile to issue loans and mortgages.   At this point, it seems unlikely that the US Federal Reserve will be raising interest rates soon which will create a challenge for the financial institutions in the US.

The low-interest rate is designed to stimulate economic growth and since the drop in interest charges in 2008 to just above zero in an attempt to improve the economy in the US, the rate has not increased by an appreciable percentage since then.  Although this has seen a slight economic revival in the US, there are a number of other factors that are influenced by the lower rates.

There are a marked stimulation to the real estate market as more people buy and sell in this sort of economic climate, as well as an increase in construction, sales on bricks, timber and other home improvement products.   The vehicle sales and finance industry also improves due to lower borrowing costs on new and used vehicles.  The share prices have also been boosted by the lower interest rates.

Saving money becomes less attractive in this type of market though as inflation may outstrip the earnings due to the almost zero interest rate earned on savings accounts.  This also reduces investments and retirement savings which can put further strain on the government at a later stage as more pensioners become reliant on government entitlements.  Fewer savings and investments reduce economic expansion as well as long-term growth.  This also reduces a number of funds available to banks to use for issuing loans and mortgages.  Financial institutions then need to borrow more funds which will lead to additional costs and lower profits for the banking sector.

Lower interest rates also encourage consumers and business owners to take on more debt as the lower repayments seem attractive and a quick way to finance goods and equipment cheaper.  If these rates are not fixed, which is often the case, this can see the debts becoming unmanageable as interest rates rise and repayments become higher.  Where excessive debt has been created, just a small increase in the interest rate can see consumers and businesses floundering.  Once the interest rates have increased, selling items such as a home or building also becomes more difficult, so it is often extremely difficult to get out of debt again at such a juncture.

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