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Key moves for surviving low interest rates

Wednesday - 2/1/2012, 4:32pm  ET

By CANDICE CHOI
AP Personal Finance Writer

NEW YORK (AP) - Interest rates aren't budging anytime soon. That means it's time to rethink your financial strategy.

The Federal Reserve said last week that it would keep its benchmark rate at record lows for at least another three years.

For savers, the prospect of persisting low rates may mean it's finally time to consider alternatives to the savings accounts and certificates of deposit yielding stingy returns of less than 1 percent.

For borrowers, the promise of low rates may be the assurance you were seeking to start researching a new car, a mortgage refinancing or to become a homeowner.

"Rates have been low for so long now that consumers have gotten complacent about it," said John Hudson, chair of government affairs at the National Association of Mortgage Brokers.

Whatever your situation, the Fed's announcement at least gives you a degree of certainty about the future. That in turn could provide the confidence to act on the big money decisions you've been contemplating.

With rates staying low through 2014, here are some moves to consider:

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CDs & Savings Accounts

You don't need to close out your savings accounts and become a day trader just yet. But it may be time to start thinking about ways you can take on a little more risk while staying in your comfort zone.

The purpose of CDs and savings accounts, after all, is primarily to preserve the purchasing power of your money. But that's likely not happening with inflation of 3 percent last year outpacing even the best returns on cash accounts.

The average yield on a one-year CD, for example, is just 0.34 percent, according to Bankrate.com. That's compared with 3.44 percent five years ago. Savings accounts are even stingier, with the average yield barely registering at 0.10 percent. Even the more generous rates offered by online banks aren't far north of 1 percent.

And once banks start paying higher rates, they'll still have a long way to go before they reach pre-recession levels, notes Greg McBride, a senior analyst with Bankrate.com.

"Unfortunately for savers, there's really no light at the end of the tunnel," he said.

That means you'll want to offset the minimal yields you're earning on savings accounts and CDs. McBride said this could be as simple as diversifying with investment-grade bonds, dividend paying stocks or inflation-linked bonds.

Mortgages

If you've been thinking about refinancing or becoming a homeowner, you can rest easy about mortgage rates. The bigger concern is whether you'll be able to capitalize on today's historically low rates.

Even as the economy has picked up, banks have kept their tightened lending standards in place. That means they're checking out financial backgrounds with greater scrutiny, including your job stability and credit report.

So even though the average rate on a 30-year mortgage remains below 4 percent, a spotty credit history will mean you'll pay far more. The upside now is that you have time to improve your credit score before applying.

If your goal is to refinance, keep in mind that some new variables may impact how much you'll be able to save. The general rule of thumb is that borrowers need to shave at least 1.5 to 2 percentage points from their rate in order for the refinancing costs to be worthwhile.

But your monthly payment may not be that much lower if your mortgage insurance rises. That could be the case with new loans from the Federal Housing Administration, which raised mortgage insurance premiums to 1.15 percent a month last spring, said Hudson of the National Association of Mortgage Brokers. The mortgage insurance for loans issued prior to that was 0.55 percent a month.

To see if a refinancing is worthwhile, start by noting the total cost stated in the "good faith estimate" form that lenders are required to provide. The loan officer should also be able to help determine what your total monthly payment would be after the refinancing. After determining how much you'd save each month, see how long it would take to recoup that cost.

Credit Cards

The Fed's announcement should theoretically be good news for credit card holders. This is because the majority of credit cards have variable rates that are impacted by the Fed's rate.

The prime rate and federal funds rate don't necessarily move in lockstep with each other. The prime rate reflects the actual rates at which banks are lending to each other and is determined by the market. It's used to peg rates on home equity loans, certain credit cards and other consumer loans. So even if the prime rate is steady, banks could increase that spread between the prime rate and the rate they charge customers to boost their profits. This is exactly what happened during the downturn as credit card issuers struggled to recoup losses from rising delinquencies and compliance with new regulations.

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