How You Can Take Advantage of the Fed's Low Interest Rate Commitment

Federal Reserve Ben Bernanke Low Interest Rates
Federal Reserve Ben Bernanke Low Interest Rates

Two months ago, the Federal Reserve began a third round of bond buying. Dubbed "QE3," its latest plan to boost the economy hinges on purchasing mortgage-backed securities at the barn-burner rate of $40 billion a month -- nearly half a trillion dollars a year.

Simultaneously, the Fed made Americans a promise: In pursuit of that goal of economic recovery, it will keep buying bonds -- as many as necessary, for as long as necessary, to ensure that the federal funds rate (the rate at which the Fed loans money to banks) is at essentially zero percent "at least through mid-2015."

The objectives here are twofold: First, to lower the cost of borrowing and make it easier for banks to lend, for borrowers to borrow, and for consumers to spend. Second, and corollary: The Fed aims to make interest rates on consumer deposits so low that there's really no point in saving money at all -- so again, you might as well go out and spend it.

How's That Plan Working Out?

Not well, according to a recent study by (RATE). Despite historically low interest rates that discourage saving and encourage spending, 74 percent of Americans polled say they are not, in fact, "inclined to borrow money despite the Federal Reserve's recent pledge to keep interest rates low until mid-2015." Indeed, less than one shopper in four (23 percent) say they're taking advantage of the Fed's low interest rates by borrowing more.

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Such consumer sentiment is to be expected. If you think about this from a consumer's perspective -- and after all, we're all consumers here -- what does the Fed's pledge mean to folks who have been assured low interest rates are here to stay?

For mortgage borrowers, Fed Chairman Ben Bernanke's pledge basically means there is no rush to buy a new home today, or even to refinance an existing mortgage, before interest rates go up. Rates will be low for years, so homeowners can feel free to procrastinate.

With Rates Like These ...

As for potential users of other kinds of loan products, the Fed's pledge may actually be operating as a disincentive to spend. After all, if you know that banks are borrowing at near-zero-percent interest rates, and you know the government is committing to keep on giving them free money from here to near-eternity, how fair does it feel to you that these same banks are making you pay through the nose for your credit cards?

According to, the current average interest rate consumers are paying on their cards is 16.89 percent. In contrast, the average interest rate these same banks pay on their interest checking accounts is 0.52 percent. So basically, banks are charging you 32.5 times more to borrow money from them than they're paying to borrow it from you.

As the saying goes: Nice work if you can get it.

What Does It Mean to You?

Despite the unfairness of all the above, it's important for consumers not to miss out on the opportunities provided by the Fed's long-term low-interest-rate pledge. And there are still ways to "work the system" to take advantage of it. For example:

• If it's low bank interest rates that have got you down, do something about it. Rather than settling for a measly 0.5 percent return, put your money in an exchange-traded fund that invests in high-yield dividend stocks. Over the past year, the Vanguard Dividend Appreciation ETF (VIG) has gained 6.2 percent (that's 12 times the average bank interest rate). The Vanguard High Dividend Yield ETF (VYM) is up even more -- 8.8 percent. Remember, such returns are not guaranteed, so this is for long-term money only; any funds you need to access in the next five years (or longer, for the more risk-averse) should not be invested in the stock market. Unfortunately, that means low returns for that short-term cash for now.

• Don't like the 16.9 percent interest rate on your credit cards? Don't pay it! Pay off the balance at the end of every month, and you'll never spend a penny on exorbitant interest charges. And it gets better. While banks have been loath to cut interest rates on their cards, cheap government loans have given them a lot of wiggle room to offer other benefits. Lately, card issuers including Barclays (BCS), JPMorgan Chase (JPM), and Citigroup (C) have been offering "extra points" for new cardholders -- a perk worth $400, $500, or even $600 for anyone savvy enough to grab it and not go into hock when the card comes in the mail.

• Last but not least, mortgages. The Fed's promise to hold interest rates at zero percent for three more years is nice, but remember that promises are made to be broken. Just because one Fed chairman says one thing today doesn't mean another Fed chairman (or even the same one) won't say something different a year from now. In the meantime, a 3.5 percent refinance rate is nothing to sneeze at, especially if you were paying 6.5 percent just a few years ago.

Don't procrastinate. Take the free money now. Heck, if everything goes to pot and mortgage rates drop even more in the future, you can always refinance again.

Motley Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of JPMorgan Chase and Citigroup. Motley Fool newsletter services recommend Bankrate.

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