Over the past two years, there has been a dramatic increase in interest rates from historically low levels, the impact of which has been felt by everyone, regardless of stage of life. In this episode, we take a closer look at this dynamic. We start by explaining what an interest rate is, provide some historical context for how the current environment compares to prior periods, talk about how the impact of higher interest rates varies depending on the stage of life you’re in, and wrap things up by sharing some potential strategies and opportunities that are presented by higher interest rates.
Outline of this episode
- Two perspectives on interest rates [2:41]
- The interest rate environment and your life stage [5:06]
- Where are interest rates today vs. the past? [8:45]
- How can we plan in the current environment? [12:01]
- The recap [14:47]
Two perspectives on interest rates
If you’re borrowing money - like a mortgage - the interest rate is the amount you have to pay each year on the money you’re borrowing. If you’re lending money to someone else - like depositing cash in a bank - the interest rate is the amount you earn on the money you’re lending.
Most interest rates are quoted as an “Annual Percentage Rate,” or APR. If an online bank is offering a 4% interest rate for money held in a savings account, it’s the annual amount you’ll earn on your deposit.
Interest rates vary depending on the financial product in question. Credit cards often have an annual interest rate of 20% or more. Credit cards are considered “bad debt,” whereas a mortgage is considered “good debt.” With a mortgage, the interest rate is usually much lower and you’re purchasing an underlying asset that increases in value over time.
Where are interest rates today vs. the past?
Mortgage interest rates have reached their highest level in the last 20 years. It was only two years ago that mortgage interest rates were in the 3% range, at their lowest level ever. Interest rates have doubled and in some cases tripled since then.
In the past 50 years, interest rates were significantly higher in the 1980s. This subsequently led to a period of 40 years where interest rates fell. Rates were 6–8% in the 1990s, 5–7% in the 2000s, and 3–5%, in the 2010s. They hit their low in 2021, with some mortgage rates reaching the high 2% range.
High interest rates impact the economy and slow its growth. When this happens, interest rates eventually begin falling again. An extreme jump like we’ve experienced recently is the exception - not the rule. It’s unlikely that we will experience another sharp increase anytime soon (but it’s impossible to predict). There will eventually be a normalization and decrease.
How can we plan in the current environment?
What can you do? Ensure that you’re maximizing the interest rate you’re receiving on any cash you have on hand by utilizing a high-yield savings account. Secondly, if you’re looking to make a larger purchase, consider saving longer to build up a larger down payment. When interest rates were at their historic lows, it was better to put down as little as possible to invest the excess.
You could also look at an adjustable rate mortgage to lock in a lower rate if you plan to be out of the home before the rate resets or if the rates are more likely to fall versus rise. This can lower your required payment. Focus on what you can control and capitalize on the opportunities available. The little things can add up over time.
Resources & People Mentioned
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup