What is Cheap Money
Cheap money is a loan or credit with a low interest rate, or the setting of low interest rates by a central bank like the Federal Reserve. Cheap money is money that can be borrowed with a very low interest rate, or price for borrowing. Cheap money is good for borrowers, but bad for investors, who will see the same low interest rates on investments like savings accounts, money market funds, CDs and bonds. Cheap money can potentially have detrimental economic consequences as borrowers take on excessive leverage if the borrower is eventually unable to pay all of the loans back.
BREAKING DOWN Cheap Money
When money is cheap, it is a good time for borrowers to take on new debt or consolidate existing debts. The borrower can take out new loans at a lower cost of borrowing, or interest rate, than the previous loans. They can then use the new loan money to pay off the old loans. This is a way of refinancing debt and ends up costing the borrower a lower fee for interest over the life of the loan, saving them money. Regardless of how cheap money becomes, a borrower should always be careful that they are able to pay back the loan, even if rates happen to go up. Taking out cheap loans with low payments based on a low introductory interest rate which then ballooned was one of the catalysts of the global financial crisis of 2008. When borrowers could afford to make their payments after the interest rate reset and their payments increased, structured products backed by those loans imploded. Bad debt, fueled by a desire for cheap money, brought down the economy.