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The Risk of Low Interest Rates

Amidst uncertainty if the Fed will spike interest rates, an article released Monday by Seeking Alpha argues that low interest rates could be the cause of lending risks, but why?

The article reveals the process of how low interest rates can lead to causes that implement risk. This starts with a bond bull market, which means that the price of bonds is high and “the higher the quality of the bond, the higher the price.”

In addition, when bond prices go up, yields go down. Similarly, safe bond prices go up when interest rates go down.

It is important to note that lower yields mean lower mortgage rates, and mortgage rates are directly tied to the yield of treasury bonds. Additionally, low interest rates don’t allow for refinancing, because if a borrower wants to refinance their mortgage the only thing that can happen is a lowering of interest rates.

So what type of risk comes with buying a safe bond with a 4 percent yield? According to the article, “this bond would cost more than the bond will pay back when it matures.”

When inflation has ruined an initial investment, then investors must look for another way to receive revenue, as this low interest rate situation “sets the stage for alternatives."

According to the report, “alternatives are ways to raise money by pledging not just assets, but also cash flows to you the lender.”

However, these alternative forms of income come with some major risk, as it results in relying on “someone else’s mortgage or the cash flows” to back the money lent from a business. Today, these alternative income investments are tempting for “institutions that must deliver more income than they can get from safe investments.”

Reminder: Being a beneficiary of any of these investment pools makes the risk is even higher.

About Author: Nicole Casperson

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Nicole Casperson is the Associate Editor of DS News and MReport. She graduated from Texas Tech University where she received her M.A. in Mass Communications and her B.A. in Journalism. Casperson previously worked as a graduate teaching instructor at Texas Tech's College of Media and Communications. Her thesis will be published by the International Communication Association this fall. To contact Casperson, e-mail: [email protected]

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