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Now's the time to borrow

So often in life, timing is everything. And right now, if you have the need and can afford the payments, it's time to get a loan. That's because very soon, based on where the economy, monetary policy, inflation and the financial markets are going, the cost of borrowing money should start inching higher.

But at the moment, borrowing costs have dipped, pushing the 30-year fixed-rate mortgage back below 4 percent. Indeed, since 10-year U.S. Treasury yields reached a high of more than 3 percent at the end of 2013, they've dropped back to just 2.5 percent now (up slightly from a low of 2.4 percent in late May).

So, if you need a new home, a new mortgage, a new car, a new boat, or money for a home remodeling or a new roof, move fast because the clock is ticking.

You can see this in the way bank loan officers are beginning to tighten standards at a pace not seen since the midst of the financial crisis, according to the latest Federal Reserve Loan Officer Survey. The tightening is happening aggressively in the nontraditional and subprime credit brackets while high-quality prime borrowers, for now, continue to enjoy relatively easy terms.

That could change soon, however, as banks keep draining the loan loss reserves on their balance sheets -- making them more sensitive to any increase in overall loan default rates. Plus, consumers are under some pressure currently given the recent kick up in inflation. That could have a detrimental effect on default rates should it continue.

Also, with inflation on the rise, the Fed could be forced to start tightening its monetary policy stance sooner than the market currently expects.

That's the takeaway from a new report by the folks at Capital Economics, in which higher prices leads them to believe the central bank will lift its policy interest rate from zero percent -- where it's been since 2008 -- as soon as March. By the end of 2015, they see policy rates at 1.3 percent on the way to 3 percent by the end of 2016.

If so, long-term interest rates should drift higher in sympathy as excess cash gets drained from the financial system. That will lower the supply of money and increase its cost.

And finally, even if the Fed doesn't start tightening, the creeping rise in inflationary pressure should cause the market to push borrowing costs higher as banks and other lending institutions build a buffer into their borrowing rates to insulate them from the erosion of the dollar's purchasing power. And the longer the Fed waits to take action, the more inflationary pressure could build.

For borrowers, getting a low rate now in anticipation of an upward drift in inflation is exactly the right thing to do. Why? Because if you can lock in borrowing costs before they rise to compensate for higher inflation, you can effectively lower your real, or inflation-adjusted, interest cost on the loan. Assuming your wages rise with inflation, the burden of repayment will diminish over time.

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After spending the last few years repaying (or defaulting) on debts, households have the capacity for some new borrowing. You can see this in the chart above, which compares debt service payments to household disposable income. That percentage has dropped to levels not seen since the early 1980s, well off the highs set at the peak of the housing bubble.

Said another way, if you borrow now at these rates and inflation does surge, you'll be winning one on the big banks as inflation eats into their profit margin on your loan. And who can't get excited about an idea like that?

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.