Written by: Guest | Best Company Editorial Team
Last Updated: September 2nd, 2020
Guest Post by Lexington Law
It can be tricky to get the timing right when you want to take out a loan. For instance, you want to wait for relatively low interest rates to keep your payments as low as possible. Rates may seem low now, but what if they sink even lower in the months ahead? You might feel like you missed a great opportunity. Conversely, what if rates rise in the next few months, and you end up paying more money?
Interest rates have been climbing, but the Federal Reserve seems poised to keep them level for the remainder of the year. However, an economic downturn may occur soon, and that could have implications that go beyond interest rates. Namely, a downturn could affect your job, income, and ability to pay back a loan.
Here is the bottom line: Take out a loan only if you can comfortably afford the payments and still have a significant amount of money in savings. Aim to have at least six months to a year’s worth of living expenses. If a downturn occurs, you may need to draw upon that money in savings. If you put down a large amount as a loan down payment, you risk losing that money plus your new car or house if you can no longer make loan payments.
Interest rates and loans
One thing to know is that the Federal Reserve does not set interest rates on your loans. That said, Fed policy has an indirect effect on many loans. Take car loans, which tend to be for a medium length of time such as 60 months (five years). If the Fed nudges interest rates up, the rates for auto loans are likely to increase as well and by about the same percentage. The story is similar for home equity line of credit rates, credit card rates, and rates for any line of credit. Their rates tend to go up along with an increase in the Fed's target rate.
The takeaway? Based on interest rates alone, now could seem like a good time to take out a car loan or HELOC before the Fed potentially increases rates next year.
As for mortgage rates, there doesn’t seem to be as much of a relationship, if any, between Fed interest rate increases and decreases. That said, there are a number of intriguing ripple effects relating to whether you should take out a mortgage loan. Say that you’re a potential homebuyer who is paying off relatively high-interest car and credit card loans after a Fed rate increase. Because of that, you have less money to purchase a home. The supply of buyers may dry up somewhat, which means that many sellers may be inclined to drop their asking price. A home may be affordable after all.
If you can afford a mortgage payment, it may be a good time to take out a mortgage loan. Do proceed with caution, though. Find out about the real estate market in your area, and have enough savings to be able to weather a potential economic downturn.
How a potential downturn could affect you
Economists have been predicting an economic downturn for a while now. It’s quite possible that one will occur in the next 18 months, so it’s instructive to look at how the recent Great Recession affected people who had taken out loans. Recovery began in June 2009, but many people lost their jobs or had to take pay cuts. Many lost their homes and cars when they could no longer afford to pay on them.
According to the Center on Budget and Policy Priorities, 8.7 million jobs disappeared between December 2007 and early 2010. The next economic downturn may not be as bad as the Great Recession, but there’s always the chance it will have some sort of impact on you.
If (or more likely, when) an economic downturn hits in the next few years, to what degree will you be affected? Such things can be difficult, if not impossible, to predict now. It’s hard to know if you might lose your job or have to take a pay cut. However, you can take approximate stock of these factors:
- Your savings
- Your current income
- How much money you have in retirement accounts
- How close you are to retirement
- Your medical costs and how much they might rise in the next few years
- Your current level of debt
- Future debts you plan to take on, their amounts and loan term lengths
- Your current ability to pay debts
- Your spending habits
- Whether you live below, at, or beyond your means
When you take these factors into consideration, it can help illustrate how well you are positioned to weather a recession and to keep paying any loans you take out now. For instance, suppose you have a costly medical issue. Your employer offers health insurance, and you’re able to keep these medical costs under control. If you lost your health insurance, these costs could potentially increase to a level beyond what you can comfortably afford.
So, is now a good time to take out a loan?
All things considered, it does seem better to take out a loan now rather than later if you have a firm plan to get a loan no matter what. After all, interest rates may be rising at some point in 2020, and the economy is poised to go through tough times.
It would be good to take out the smallest loan amount possible so you have less to pay back later. However, you should also keep a healthy cushion of savings in case you need it down the road. There’s a balance between spending most of your savings on a down payment and putting down very little and paying a higher amount each month. To help you predict your future costs better, opt for fixed-rate loans. That way, if interest rates go up later, your payments won’t increase.
The bottom line bears repeating: Take out a loan only if you can comfortably afford the payments and still have a significant amount of money in savings.
The economy seems headed for choppy seas, and now is a good time to be whittling away at your debt instead of not taking more on if you can help it. Of course, everyone’s situation is unique. Maybe you’re paying too much in rent right now, and you find a great, reasonably priced house that means significantly lower monthly payments. Likewise, if your car is in bad shape and you constantly have to pay for repairs, it may be a smart financial move to get a different car, even if that means taking out an auto loan. Everyone’s situation is different and you know your finances better than anyone else.
The decision to take out a loan also depends on what you uncover about potential lenders and on factors such as interest rates. To find out about lenders, interest rates and more, check out BestCompany reviews on business loans, car loans, and personal loans. If you need help with debt relief, these companies may be able to offer the assistance you want.