How to Make the Most of Low Interest Rates

By: Jeff Brown

The Federal Reserve’s plan to keep interest rates low for longer than expected has thrilled stock investors, encouraged borrowers and put fixed-income savers into a funk .

How can ordinary people make the most of the situation?

On Nov. 3, the Fed announced plans to spend $600 billion to buy government securities to stimulate the economy. That increased demand should push bond prices up, causing yields to fall. It means mortgage rates will stay low or go lower while leaving savings yields in the basement.

Action in the futures markets indicates traders now think the Fed won’t reverse course and start raising interest rates until June 2012. However, earlier this year, many experts thought rates would be rising by now.

Low rates, of course, are great for borrowers. The average rate on the standard 30-year fixed-rate mortgage is a mere 4.476%, according to the BankingMyWay.com survey .

Would it now make sense for a mortgage shopper to hold off on getting a lower rate? There’s no guarantee the rates will fall further, but now there seems to be less reason to worry that they will rise.

With this in mind, a homeowner who’s thinking about refinancing has the luxury of time. There’s probably nothing to lose by waiting a few weeks to see what rates do. But keep in mind there are always some lenders offering market-beating deals. Bank of America (Stock Quote: BAC ), for instance has some mortgages at 4.125%.

Instead of focusing on the rate, take a close look at other expenses like points and fees, as higher costs can easily wipe out the savings from a slightly lower rate.

Mortgage shoppers with a taste for risk or a short ownership horizon should take a look at adjustable-rate loans. The five-year ARM looks particularly intriguing, offering an average rate of 3.428% for five years before starting annual adjustments.

If you’ve been planning to refinance an ARM you already have, there’s now less reason to hurry. The Fed’s policy should keep rates very low on the indexes used for ARM resets, so you could pay much less on your ARM over the next year or two than you would on a new fixed-rate loan. Many ARMs tied to one-year Treasury securities are resetting to about 3%.

The Fed’s plans also give home shoppers some breathing room, as there’s a good chance you’ll pay no more for a mortgage in six months or a year than you would now. Unless you’re forced to buy a new home for a job move, think about taking it slow and waiting for solid evidence home prices will not fall further.

What about savings? Well, it’s time to focus on the silver lining. Savings yields are terribly low but, fortunately so is inflation. This means your savings won’t lose as much spending power. Also, FDIC-insured bank savings are safe.

To earn a bit more, take a look at five-year certificates of deposit. Yields average 1.6%, and the search tool shows a few banks paying around 2.7%, while some credit unions beat 3%.

The Fed’s renewed commitment to keep rates low for an extended period of time probably means there isn’t much to lose by locking your money up in a five-year CD.

If CD rates suddenly rise, however, you could pay a penalty to pull your money out early and reinvest. Just be sure to find out what that penalty would be. Typically, it’s a loss of six-months’ worth of interest earnings.