What the Fed’s Interest Rate Cuts Mean for You
If you follow any major news outlet, you're probably aware that the Federal Reserve Board has cut the interest rate several times since 2008 began. But, unless you're an economics enthusiast, you may not know what all this rate cutting means for the general economy, or how it will affect your finances.
Before we outline some of the changes you can expect, it's important to understand that the Fed is cutting the "federal funds rate," or the rate at which banks lend money to each other. The "prime" rate, or the rate at which banks typically lend money to individual borrowers, is linked to the federal funds rate. Generally, the two differ by about three percentage points.
Here's a summary of which of your investments you can expect to be affected by the ever-lowering interest rates.
Payments for Adjustable-Rate Mortgage (ARM) Linked to the Prime Rate
Changes in the federal funds rate will lead to changes in the prime rate, which will likely mean reduced monthly payments in the form of lowered interest for those with adjustable-rate mortgages. If you have an ARM, now might be a good time to refinance to a fixed-rate mortgage, since you may be able to get a reasonably low interest rate.
Those with home equity lines of credit, too, may benefit from the Fed's rate cuts. With lower interest rates, credit may be less expensive, which may make some borrowers more likely to catch up on debt.
Fixed-rate mortgages will remain largely unaffected, since their interest rates are tied to long-term bond yields rather than short-term federal funds rates.
Unfortunately, the savings for those with ARMs may not be significant enough to prevent default or foreclosure for homeowners seriously behind on payments. For now, the rate cut will likely have major impact only on those homeowners who are slightly behind on home payments.
Payments on Variable-Rate Credit Cards
The good news is that interest rates on credit cards with variable rates are linked to the federal funds rate, which means that interest will likely decrease for those with variable-rate cards. The bad news, though, is that you probably won't see any significant savings unless you have serious credit card debt.
While savings in mortgage payments can total thousands of dollars, the generally smaller amounts of credit card debt translate to smaller savings from a rate cut. But, all things considered, you're probably better off saving less and having less debt.
Those with fixed-rate credit cards could also benefit by transferring balances to cards with lower interest. But keep in mind that transferring credit card balances is an important decision, and should not be made lightly. If you decide to transfer balances, be sure to read the entire credit card agreement before signing it and asking for clarification from a trusted source if you have any questions.
Auto Loan Rates
If you've been planning to buy a new car, now might be the time to do so. Since auto loans are among the short-term loans affected by fluctuations in the federal funds rate, they've decreased since the Fed cut rates.
Keep in mind, though, that a new car is only a wise purchase if you truly need one and have determined that you can afford to make regular monthly payments.
Interest Rates on Savings Accounts
Here's the downside of the rate cuts: if you've got money in a high-yield savings account, you'll likely see a decrease in returns because of the Fed's rate cut. The Fed effectively made money cheaper to borrow, so your money can earn less interest. But don't worry about that too much, as having a savings account is important and shouldn't be eliminated for this reason.