What does a Federal Reserve interest rate cut mean for you and your finances? Money Girl explains how making some smart money moves now can work in your favor.
On March 3, the central U.S. bank, also known as the Federal Reserve or Fed, made a surprising emergency interest rate cut of 0.05% to the federal funds rate. That’s the largest single rate cut we’ve seen since the 2008 financial crisis.
It’s the Fed’s job to maintain stability in the economy by raising or lowering the cost of money. Their latest move was an aggressive effort to prepare for any potential problems that could arise in markets due to the spread of the coronavirus.
The Federal Reserve just made the largest single rate cut we’ve seen since the 2008 financial crisis.
Any rate change the Fed makes trickles down and affects many aspects of our personal finances. Let's review six ways the most recent rate slash could help or hurt you. You’ll learn some smart moves to make now so the lower interest rate can work in your favor.
Financial accounts affected by an interest rate cut
Here are common ways that the interest rate cut will trickle through the economy and affect your finances.
1. Credit cards
Since most of us have at least one credit card, it’s an account that you’re likely to see changed by the interest rate cut. As I covered in What Is Credit Card APR?, many credit cards come with a variable rate that’s tied to a financial index such as the prime rate.
When the Fed’s benchmark rate (which is the federal funds rate) changes, the prime rate moves in lockstep. That means your card’s variable APR can also go down. However, it depends on the type of card you have and your issuer.
For the majority of cardholders with variable APRs, you probably will see your rate drop by half a percent within the next month or two.
Some rewards cards with high APRs may not fall substantially or at all if they offer generous points or rewards programs that are costly to the issuer. If your agreement with the issuer doesn’t say that the card rate will go down when something like a prime rate decrease occurs, it probably won’t.
But for the majority of cardholders with variable APRs, you probably will see your rate drop by half a percent within the next month or two. For example, if your card’s APR is 20%, your adjusted rate could go down to 19.5%.
While a 0.05% drop may not seem like a tremendous amount, every little bit helps when you carry a balance from month to month. If your variable card rate doesn’t go down, it may be an excellent time to shop for a lower-rate card that would cut your interest expense and save money.
Remember that if you have a fixed-rate credit card, it’s APR won’t change no matter what’s going on with the economy or federal rates. Also note that if you pay off your balance in full each month, a credit card’s APR is irrelevant because you never pay any interest on your purchases. So, pat yourself on the back if you’re only making card charges that you pay off month after month!
Many factors affect mortgage rates, including what’s happening in the real estate market, the general health of the economy, the inflation rate, and long-term expectations. While the Fed doesn’t control mortgage rates directly, when they cut the federal funds rate, it causes other changes that do affect mortgage rates.
The recent interest rate cut makes it easier for banks to lend money at lower rates, which means getting a new mortgage or refinancing can cost less. So, it’s a great time to consider buying a home if you’ve been on the fence!
If you already have a fixed-rate mortgage, consider whether refinancing it at a lower rate could save money. Contact your lender to find out what fees they require and how long it would take to break even on a refinance. That’s the length of time you must own your home before you start saving money from lower monthly payments.
The recent interest rate cut makes it easier for banks to lend money at lower rates, which means getting a new mortgage or refinancing can cost less.
When you plan to sell your home soon, such as in a year or two, doing a refinance probably won’t make financial sense. Also, you need a certain amount of equity in your home to qualify for a refinance. If your loan-to-value ratio is too high, you won’t be able to take advantage of lower mortgage rates. Remember that today’s mortgage rates are still incredibly low from historical standards, so don’t worry if you can’t do a refinance right now.
If you have an adjustable-rate mortgage or ARM, you’ll likely see your rate tick down. However, it could take several months, as these loans generally only reset once or twice a year. Your rate won't go down as much as with a variable rate credit card. Nonetheless, your monthly ARM payment becomes more affordable.
3. Home Equity Lines of Credit (HELOCs)
If you’re a homeowner, in addition to a mortgage, you may also have a HELOC. You can think of it as a mash-up of a credit card and a mortgage. It allows you to borrow a portion of your home’s equity up to a credit limit set by the lender. Many homeowners use HELOCs to make home repairs or even pay for a child’s education expenses.
It's also an excellent time to shop for a low-rate HELOC if you have equity in your home that you'd like to tap.
HELOC rates are typically variable, so they'll adjust quickly to the Fed's rate cut. Similar to a credit card, a HELOC rate is generally tied to the prime rate, which tends to follow changes to the federal funds rate.
That's good news if you have an outstanding balance on your HELOC because your minimum monthly payment will go down. It's also an excellent time to shop for a low-rate HELOC if you have equity in your home that you'd like to tap.
4. Auto loans
Auto loans come with fixed interest rates, so the recent Fed rate cut won’t affect what you’re currently paying on an existing loan. However, if you’re in the market for a new car, you might see rates dip a bit. That could allow you to buy a more expensive vehicle or to get a lower monthly loan payment.
5. Student loans
If you’re still paying off federal student loans, they have fixed interest rates, which don’t change no matter what’s going on in the economy. However, the rate for new federal loans typically adjusts every year in May, based on Treasury rates. So, the Fed’s latest rate cut could cause loans distributed for the next academic year to be lower.
There are also private education loans, which can have fixed or variable rates. They’re typically tied to a financial index, which means they can go down when the Fed cuts interest rates.
While you can’t refinance federal student loans, you can refinance private loans to lock in a lower fixed rate. So, if you have private student loans, check with your lender to see if refinancing makes sense and could save money.
6. Bank Savings
As you can see with the five credit accounts that we’ve covered, the Fed interest rate cut is beneficial for many borrowers. But the downside to a rate cut is that it squeezes savers. The interest rates paid by banks on a savings or a money market account moves in step with the federal funds rate.
Right now, the average savings rate is only a fraction of a percent. It’s hard to get much lower than that, but savings rates could still dip slightly. Other bank products, such as certificates of deposit (CDs) and money market accounts, will also move lower.
A wise tip for savers is to shop around for high-yield savings accounts, which typically only come from online banks and nationwide credit unions.
A wise tip for savers is to shop around for high-yield savings accounts, which typically only come from online banks and nationwide credit unions. The interest payout won’t be stellar, but it’s higher than what you’ll get from a traditional brick and mortar bank.
Even though saving rates are low, don’t let that discourage you from saving and creating a cash cushion that you can fall back on. Remember that the point of having an emergency fund is to protect your finances if you lose your job, business income, or have unexpected expenses.
The goal isn’t to aggressively grow your cash reserve or to subject it to any amount of risk. Otherwise, it could be wiped out at the moment you desperately need it. So, even though interest earnings on savings are low and could go lower, remember that’s the price you pay to keep your cash completely safe.