How to Survive a Recession

LESSON 35: Lock in Long Term Rates

When interest rates are low, it is possible to “lock in” low cost financing for long periods. The idea is to acquire the lowest interest rate possible for the longest time period. By borrowing at a fixed rate over a long time period, low payments continue forward into the next economic growth cycle when interest rates naturally rise. This reduces both your current and future cost of the loan. Locking in long term rates applies to both businesses (property, plant, equipment, R&D, marketing costs) and individuals (home, credit card, and auto debt).

There are two competing factors in the decision to choose long or shoert term financing:

First, consider the higher cost of long maturity loans versus short maturity loans. To compensate for the increased risk of making a 30-year loan versus a 5-year loan, for example, lenders either require more collateral or a higher interest rate. With minimal liquid collateral, it is often difficult to acquire long-term financing at a reasonable cost. Therefore, long term loans are primarily available to borrowers with strong net worth or specific unburdened marketable assets (such as securities) that can be used as collateral.

Second, you need to time the financing so that it coincides with the lowest interest rate possible. This is quite difficult to do. The general rule would be “the longer the recession has been in effect, the longer the borrowing term.” One tool is to follow the major economic indicators outlined in this book. As the leading economic indicators begin to transition out of recession, this is the optimum time to seek long term loans. This helps get the economic growth trend on your side, alleviating any timing errors and the need to re-finance if rates continue on a downward trend.