Volume 13, Issue 5  
Interest Rates Affect Your FINANCIAL SITUATION

when discussing bank accounts, investments, loans, and mortgages, interest is an important concept to understand. In financial terms, interest is the price paid for the temporary use of someone else’s funds, and an interest rate is the percentage of a sum borrowed that is attributable to interest. Whether you are a lender, a borrower, or both, it is important to consider how changing interest rates may affect your financial decision making.

The Purpose of Interest

Borrowing money can help you accomplish a variety of financial goals, and the cost of borrowing is interest. When you take out a loan, you receive a lump sum of money up front and are obligated to pay it back over time, generally with interest. Because of the interest expense, you end up owing more than you initially borrowed. The tradeoff, however, is that you receive funds to accomplish your goals, such as buying a house, funding a college education, or starting a business. Given the cost of interest, which can add up significantly over time, it is important to make sure that any debt you assume is affordable and worth the cost over the long term.

To a lender, interest represents the compensation for the service and risk of lending money. In addition to giving up the ability to spend the money at the present, a lender assumes certain risks. One obvious risk is that the borrower will not pay back the loan in a timely manner, if ever. Inflation creates another risk. In general, prices tend to rise over time; therefore, goods and services will likely cost more by the time a lender is paid back money borrowed. Effectively, the future spending power of the money is reduced by inflation because more dollars are needed to purchase the same amount of goods and services. Interest paid on a loan helps to cushion the effects of inflation for the lender.

Supply and Demand

Interest rates often fluctuate, according to the supply and demand of credit, which is money available to be lent and borrowed. In general, one individual’s financing habits, such as carrying a loan or saving in fixed-interest accounts, will not affect the amount of credit available to the economy enough to change interest rates. However, a general trend in consumer banking, investing, and debt can have an effect on interest rates. Businesses, governments, and foreign entities also affect the supply and demand of credit according to their lending and borrowing patterns. An increase in the supply of credit, often associated with a decrease in demand for it, tends to lower rates. Conversely, a decrease in supply of credit, often coupled with an increase in demand for it, tends to raise rates.

The Role of the Fed

As a part of the U.S. government’s monetary policy, the Federal Reserve Board (the Fed) manipulates interest rates in an effort to control money and credit conditions in the economy. Because of this, lenders and borrowers can look to the Fed for an indication of how interest rates may change in the future.

In order to influence the economy, the Fed buys or sells previously issued government securities, which affects the federal funds rate. This is the interest rate that institutions charge each other for very short-term loans, and it determines the interest rates banks use for commercial lending. For example, when the Fed sells securities, money from banks is used for these transactions; this lowers the amount available for lending, which then leads to a rise in interest rates. In contrast, when the Fed buys government securities, banks are left with more money than is needed for lending; this increase in supply of credit, in turn, lowers interest rates.

Lower interest rates tend to make it easier for individuals to borrow. Since less money is spent on interest, more funds may be available to spend on other goods and services. Higher interest rates are often an incentive for individuals to save and invest, in order to take advantage of the greater amount of interest to be earned. As a lender and a borrower, it is important to understand how changing interest rates may affect your saving and borrowing habits. This knowledge can help you make wise decisions in pursuit of your financial goals.

  Straighten Up Your FINANCIAL HOUSE! TEXT

Is your financial house in order? From time to time, it’s good to straighten things up a bit. Use some of the following helpful hints to make the task a little more orderly and worthwhile:

  1. Clean the “attic.” That’s the spot where you have stored items such as old, unused credit cards, bank account statements for accounts under $10, and savings bonds you forgot to redeem. Settle these accounts accordingly.

  2. Refurnish your credit “room.” This can include refinancing your mortgage while mortgage rates remain low, transferring credit card balances to lower rate alternatives, or utilizing a home equity line that offers a low rate and tax-deductible interest. You will appreciate the new “look” you create. It can be especially pleasing to empty the “room” of some credit commitments by paying them off completely, thus giving your overall budget more breathing space.

  3. Consider a complete renovation. Is your savings plan sufficient to meet your short- and long-term goals? You may be at a stage of life that requires different tactics.

  4. Look at future “housing” needs. What accommodations have you made for your retirement? One of the best mechanisms in today’s changing world of taxes may be the 401(k) plan, which can reduce taxable income and allow tax deferral on earnings.

  5. Solidify your “foundation.” Now may be a good time to review your life insurance policies. The plan you established years ago may need to be updated according to your current needs. Setting up an annual review with your insurance professional can be instrumental in ensuring the adequacy of your coverage.

  6. Protect your home. Update your homeowners policy and make a videotape of your home—both inside and out. Be sure to include your valuables. Store the tape in your safe-deposit box, and add to it as the need arises.

  7. Dust off your tax records. You never know when the IRS may inquire into your old tax returns, so make sure they are in order. You may also want to speak with your tax professional regarding any changes you need to make to brighten your tax picture before filing your return.

  8. Establish a regular “maintenance” program. If you haven’t done so previously, set up a budget. Make “paying yourself first”—putting a set amount into your savings and investments every month—a priority. Analyze your current spending habits, and plan ahead for large bills and expenses.

It is always more relaxing to live in a clean and orderly home. By taking these steps, your financial “home” may become an inviting, enjoyable corner of your life!


One “extracurricular” activity that every student should master while in college is personal money management. Typically, a student’s day-to-day spending is done on an improvised basis, meaning that overspending is often the norm rather than the exception.

It is estimated that during a school year, the average college or university student will spend over $3,000 for books, supplies, transportation, and personal expenses (Trends in College Pricing—2006, The College Board). However, there is often room for economizing. The first place to look is at food and telephone calls. Difficulty may occur in controlling these expenses, especially if pizza is ordered regularly at 2 AM and long-distance friends are simply a phone call away.

While many students may assume it costs less to live off campus than in a dorm, they may be in for a surprise. In college towns with a high demand for off-campus housing, accommodations within walking distance of the campus may tend to be expensive. Some landlords require a one-year lease—a period longer than the school year—thus, subleasing privileges should be included as part of an “economical” lease. However, off-campus students can save money by sharing housing and doing their own cooking.

Money Smarts 101

  1. Before your student leaves for college, sit down and have an open discussion of expectations—both your child’s and yours.

  2. Consider providing a lump sum each semester, setting a guideline on how long the money must last.

  3. Explain when checks or money transfers can be expected, the amount he or she will receive, and any rules concerning use of the funds.

Since most students rely on savings and checking accounts—regardless of whether it includes their parents’ funds, their own, or a combination of both—it is important for them to understand how they work. The ability to balance an account accurately and make needed corrections is especially critical.

Many undergraduates may keep most of their funds in hometown financial institutions. However, managing financial affairs long-distance can be difficult. Verifying an account balance quickly with an out-of-state bank can be difficult and time-consuming. In addition, trying to get money to college students in different locations can be frustrating. So, it may be a good idea to keep a smaller account on campus.

While some parents may fear a credit card can give too much of a cushion to a student who has difficulty managing his or her affairs, others find a credit card can provide a useful backup, especially in an emergency or for certain expenses. For instance, it can help with car rentals, plane fares, and railroad tickets.

Making the Grade

Ideally, college students should take full charge of a semester’s spending. Life becomes much easier for parents whose college-age children can manage their own finances. And, the future may look brighter when your student “makes the grade” in personal financial management skills.

Pros and Cons OF PROBATE

The responsibilities of the probate court are to determine that a will is valid and to ensure that it is faithfully executed. Although most states have exemptions for smaller estates, a will ultimately falls under the jurisdiction of the probate court.

A trust is similar to a will in that it deals with the transfer of assets. Testamentary trusts are subject to probate because they are created by a will at death. If you wish to avoid probate, one way is to use a “living” or inter vivos trust.

The probate process has advantages and disadvantages. Here are some points to consider in determining howprobate could affect your estate.


  • Fair Estate Value. If your heirs believe your property has been overvalued, thus potentially increasing the estate tax, a lawyer or executor can bring in an independent appraiser. The judge may approve the new appraisal or take a position between that of the independent appraiser and one appointed by the court.
  • Protection from Creditors. Once an estate has been probated and its assets distributed, creditors cannot make any further claims against the assets.
  • Lower Legal Costs. Drafting a will is often less expensive than drafting a living trust or other legal document in an attempt to avoid probate.


  • Higher Costs to the Estate. Probate can be a costly process. Fees are set by law in some states, and they may be based on gross, rather than net, values. They generally cover only “ordinary” services. If an attorney performs “extraordinary” work, the fees may be even greater. The executor may also charge fees, and unless those fees are waived, the cost to the estate may double.
  • Delay Transferring Assets. Settling an estate in probate can take as long as one or two years. During the settlement period, assets in probate often suffer from overly conservative management. In some states, it can take a month or more simply to receive court permission to sell an asset. This may often prevent an executor from being able to respond to sudden changes in market conditions. Executors may also tend to act conservatively during probate since they may be financially liable if they are judged to have been less than prudent.
  • Public Knowledge of the Estate. The probate process is a matter of public record. Thus, a will is open to public scrutiny.

Probate laws vary from state to state. It is best to meet with a qualified legal professional to determine how the probate process may affect your estate, and whether you might wish to consider a living trust as an alternative.

The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Entities or persons distributing this information are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.

The information contained in this newsletter is for general use and it is not intended to cover all aspects of a particular matter. While we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. Therefore, information should be relied upon only when coordinated with professional tax and financial advice. The publisher is not engaged in rendering legal, accounting, or financial advice. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any securities. This newsletter is published by Liberty Publishing, Inc., Beverly, MA, COPYRIGHT 2007.