Karungi: Understanding the costs of Interest rates

By dianekarungi@gmail

In December 2007, most economists in the U.S realized that the economy was slowing prompting most of them to predict an outright recession.

The Federal Open Market Committee (FOMC) also projected that the unemployment rate in the fourth quarter of 2010 would average 5 percent. But by the end of 2008, with the economy in the midst of a deep recession, the unemployment rate had risen to about 7.5 percent; and a year later, it reached 10 percent.

This forced the Fed adopt some unconventional policies, such as the purchase of $1.25 trillion of mortgage-backed securities as a dual- track to respond to financial and recession crisis.

FOMC reduced its interest rate target to near zero in December 2008 and indicated its intent to maintain a low interest rate environment for an “extended period.”

Ms Diane Karungi, The Parrots economist discuses on the benefits, costs of interest rates and how collateral securities help to maintain extremely low costs on interest rates.

Since collateral lowers the “risk factor” for lenders, they’re able to offer more reasonable interest rates on secured loans. Without this security, interest rates rise in order to ensure that the lender makes a profit off the loan whether or not you pay it in full. Dealing with higher interest rates ties up assets and hinders business growth, but putting up collateral can greatly reduce your monthly payments.

With less interest to deal with during each payment cycle, it’s easier to manage your company budget. As long as you plan to use the loan money wisely and put the interest savings back into the business, you should be able to benefit from this perk of collateral based loans.

Benefit of low interest rates is that they can raise asset prices. When the Fed increases the money supply, the public finds itself with more money balances than it wants to hold. In response, people use these excess balances to increase their purchases of goods and services and of assets like houses or corporate equities. Increased demand for these assets, all else equal, raises their price.

The lowering of interest rates to raise asset prices can be a double-edged sword. On the one hand, higher asset prices increase the wealth of households (which can boost spending) and lower the cost of financing capital purchases for business. On the other hand, low interest rates encourage borrowing and higher debt levels

In lending agreements, colleteral is a borrower’s pledge of specific property to a lender, to secure repayment of a loan. The collateral serves as a lender’s protection against a borrower’s default and so can be used to offset the loan if the borrower fails to pay the principal and interest satisfactorily under the terms of the lending agreement.

The protection that collateral provides generally allows lenders to offer a lower interest rates on loans that have collateral. The reduction in interest rate can be up to several percentage points, depending on the type and value of the collateral. For example, the interest rate (APR) on an unsecured loan is often much higher than on a secure or logbook loan, as the risk for the lender is then increased.

If a borrower defaults on a loan (due to insolvency or another event), that borrower loses the property pledged as collateral, with the lender then becoming the owner of the property. In a typical mortgage loan transaction, for instance, the real estate being acquired with the help of the loan serves as collateral.

 If the buyer fails to repay the loan according to the mortgage agreement, the lender can use the legal process of fore closure to obtain ownership of the real estate. 

A pawnbroker is a common example of a business that may accept a wide range of items as collateral.

The type of the collateral may be restricted based on the type of the loan (as is the case with auto loans and mortgages); it also can be flexible, such as in the case of collateral-based personal loans.

Karungihttps://theparrots08.blogspot.com Diane is a second year Accounting and Finance student at Uganda Christian University (UCU) – Mukono Main Campus.

She’s a poetess, essayist and author at The Parrots.

E-mail: dianekarungi@gmail