Banks serve two main purposes. They provide loans to consumers who need a helping hand, and they provide a place to store cash, also known as a deposit.
The two actions aren’t independent of each other, and are actually very much interconnected.
For example, banks lend money out a certain rate and pay customers a certain return if they keep their money at the bank.
The two rates rely on one another to ensure the bank makes money. The short version of the story is that the bank must pay depositors less than what it charges to lend.
That’s why we see mortgage rates on the 30-year fixed around 4%, and savings accounts paying closer to 1% APY. This spread allows banks to make money and continue lending to consumers.
Low Mortgage Rates Are Bad News for Those Who Don’t Have a Mortgage
While everyone has been banging on about low mortgage rates for years now, many fail to mention that savers (and really anyone without a mortgage) are getting the short end of the stick.
As noted, when interest rates on loans move lower, as they have over the past several years, savings rates must drop as well, seeing that the two tend to move in tandem.
Before the financial crisis, it was actually quite common to see savings rates in the 3-4% APY range, which certainly wasn’t bad from a saver’s point of view.
Banks were offering great savings rates because they needed more money in the coffers to lend out to consumers, who were especially hungry for loans.
Remember, banks were going haywire making new loans during the housing boom, so they also had to attract depositors to ensure they had collateral.
Interestingly, the gap between savings and mortgage rates wasn’t all that wide back then, with the 30-year fixed ranging between 5-6%, compared to around 4% today.
Meanwhile, savings accounts were commonly in the 3% or higher range if you went with a bank that offered a more aggressive return.
Today, the gap between one-month CD rates (0.06%) and the 30-year fixed (4.5%ish) is the highest it has been since mid-2011, according to MoneyRates.com, which releases the so-called “Consumer’s Lost Interest Percentage (CLIP) Index.”
The company noted that the gap widened to 4.43% in September, up three basis points from August. It has increased by a staggering 1.15% so far this year thanks to rising mortgage rates and savings rates that “haven’t budged.”
The average gap between CD rates and 30-year fixed mortgage rates since 1971 has been 2.83%, meaning today’s gap is 1.6% above the norm.
So What Do You Do with Your Money?
With the gap so wide, it’s clear that those with the bulk of their assets in low-paying savings accounts are losing out.
At the same time, mortgage rates are at near-record lows, so one has to scratch their head a little.
Do you pay down the mortgage early, which has an ultra-low rate that will probably never be lower? Or do you throw your money into a savings account that is paying next to nothing?
Or, do you say to heck with savings accounts and try your luck in the stock market, which also happens to be sky-high currently?
It’s certainly not an easy decision, and it’s clearly not good news for renters and those who have already paid off their mortgages.
But perhaps the best option is to tackle other high-APR debt, such as credit cards, which tend to have interest rates in the teens and higher.
If the only debt you have is mortgage debt, there are plenty of ways to pay down your mortgage a little quicker, including going with a shorter-term mortgage, such as the 15-year fixed. That will reduce the gap as well, seeing that rates on 15-year loans are lower than those on 30-year mortgages.
But you might regret locking that money up a few years down the line if both savings and mortgage rates go up, especially if inflation rears its ugly head.