When the economy is good, it often seems like it will stay that way forever. But if you study history — or just live long enough — you’ll realize that future recessions are inevitable. That’s why many people want to know what will happen to interest rates in a recession.
If you have a home loan, car loan, or personal loan, or you pay interest on your credit cards, you may wonder: Do interest rates go up in a recession? In general, interest rates during a recession actually tend to go down. Read on to learn why and how recession interest rates can impact your financial decisions.
Related: How rising inflation affects mortgage rates
What Is a Recession?
Most people simply consider a recession to be a time when the economy is weak. However, the technical definition of a recession is two consecutive quarters of economic decline in the gross domestic product (GDP) along with other indicators, such as a rise in unemployment.
How Do Recessions Affect Interest Rates?
During a recession, interest rates tend to fall as the government attempts to stimulate the economy. With lower interest rates, it’s less expensive to borrow money. On the flipside, you’ll also earn less interest from saving your money. As more people spend money thanks to lower rates, the hope is that the economy will grow stronger and the recession will end. For instance, with lower interest rates, consumers can more easily buy a home or car or finance another large purchase.
Supply and Demand
Interest rates, like the prices of many other goods and services, are partially determined by market forces, including supply and demand. While interest rates generally decline during a recession, one factor that could cause interest rates to go up in a recession is an increased demand for loans.When a recession begins, there could be a demand for funds as businesses and consumers turn to credit to make up for falling revenue and income. This uptick in demand can create a decrease in the available supply of funds, which in turn could drive up interest rates at the beginning of a recession.
Role of the Central Bank
While supply and demand are important factors in setting interest rates, central banks also play a major role. In the U.S., the Federal Reserve Bank, commonly known as the Fed, can influence interest rates by buying and selling debt instruments, such as Treasury Bonds. During a recession, the Fed can buy up bonds. This offers additional liquidity to banks and can lead to lower interest rates. In turn, this can stimulate the economy through increased lending.
Role of Private Lenders
A private lender is a non-government bank or credit union that loans money to individuals and businesses. Private lenders also have a role in determining interest rates during a recession, either directly or indirectly. For example, private lenders may make it more difficult for borrowers to qualify for loans during a recession, as they will become far more cautious about loaning money. During a recession, you may need a higher credit score to qualify for a loan, or a loan may require a higher down payment than it did before.
Example of a Recession and Its Impact on Interest Rate
The most recent example of a recession and its effect on interest rates is the COVID-19 pandemic. In March 2020, when lockdowns began taking effect in the U.S., the average interest rate of a 30-year fixed-rate mortgage was 3.45%. However, that rate dropped steadily over the year, falling to 2.68% by December 2020.As the economy began to recover in 2021, that rate rose and fell, eventually rising to 3.10% by December 2021. And as the economic recovery continued to progress and economic growth increased, the rate reached 3.76% in February 2022.
Should I Refinance During a Recession?
Your decision to refinance your home mortgage or other debts will depend on your existing rates and the current rates available, as well as your income and credit score. If you have credit cards or personal loans, you might have the opportunity to pay off your loans sooner if you have a lower interest rate.
When it comes to refinancing your home mortgage, you could save a lot of money if interest rates during a recession have fallen below your current rate. However, keep in mind that you’ll need to pay your closing costs if you do refinance, and prepayment penalties may also apply. You’ll want to consider how much longer you plan to stay in your home and crunch the numbers before moving forward to ensure it makes financial sense.
During a recession, you might be able to secure a lower interest rate on your auto loan. Plus, refinancing an auto loan can have fewer costs than other kinds of loans. However, some auto loans may have prepayment penalties that you’ll need to look out for and take into consideration. Also, keep in mind the difference between soft or hard credit inquiries when you’re shopping around, as a hard inquiry will have an impact on your credit score when you apply for refinancing.
If you have an outstanding personal loan, and you think you can qualify for a new loan with a lower rate, then it could make sense to do so during a recession. In general, personal loan interest rates tend to fall during a recession as interest rates are cut to stimulate growth. If you can qualify for a new personal loan at a lower rate, then you can save money by using the new loan to pay off the old loan, while also enjoying lower monthly payments. Just make sure to look at the drawbacks and advantages of a personal loan before considering one.
Refinancing your student loans during a recession can be a good idea if you can reduce your interest payments. Student loans rarely have prepayment penalties. However, if you refinance a federal loan into a loan from a private lender, then you can lose some valuable benefits, such as loan forgiveness programs and hardship protections.
Recessions can be a difficult time for many who are unable to find a job, or for business owners who face lower sales. But if you’re one of the lucky ones who continue to be financially secure, then you may have an opportunity to borrow money or refinance your existing debt at lower rates.
This article originally appeared on LanternCredit.com and was syndicated by MediaFeed.org.
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