Velocity Of Money & Interest Rates

If you watch the news on a daily bases, one of the things that is often reported is Personal Spending and Personal Income.  These reports are supposed to provide a better insight into the health of our economy.  But what most people do not realize is that Personal Spending and Personal Income also influence home mortgage rates.  Personal Spending and Personal Income play a role in the interest rates that will be available at the time a home is purchased or refinanced.

The reason for this is because of what is referred to as the "Velocity Of Money".  The government has put a lot of money into the economy, especially in recent years.  But even though the government has put this money into the economy, it does not have any effect until it is actually spent, or in the case of mortgages, lent to a Borrower.  The time that it takes for this money to be spent or lent, meaning the time it takes to go from the consumer to a business, is called the "Velocity Of Money".

Because many people have been losing there jobs, and having a hard time finding new ones, they are very hesitant to spend money.  The same goes for businesses.  If consumers are not spending money, then businesses are not making the money they need to invest and improve their business. This causes the present "Velocity Of Money" to be slow, which results in low inflation, which in turn results in low interest rates.  

Many people are under the impression that interest rates are tied in to the Fed Rate, when in fact they are tied to the Bond Market.   So the lower the inflation, the better Bonds perform, and that creates low interest rates.   The opposite happens when the "Velocity Of Money" increases.  The additional spending creates inflation, which has a negative effect on the Bond Market, and as a result an increase in interest rates.

So to put this in simpler terms, a slow or bad economy means low interest rates, and a good economy means higher interest rates.  While we would all like to get people back to work again, and see the economy improve, especially with more home sales, we can make the best of the present situation by taking advantage of the historically low interest rates that are available today. 

The economy will not stay in its present condition forever, and sooner or later it will begin to improve, and bring about higher interest rates.  This means that now is a perfect time for those that can purchase a home, or need to refinance to do so.  It would be a shame if those who have the money to purchase a new home today, missed out on this great opportunity by waiting too long, and not taking advantage of the low home prices and interest rates that are available today.