Advice
When the Federal Reserve cuts rates, it generally offers some relief to Americans who have felt pinched by excessive borrowing costs. The lower interest rates would make it more affordable to borrow money and lower debt payments owed on borrowing instruments such as mortgages, student loans, and credit cards.
How does the Fed decide when to cut rates?
The decision to cut interest rates is determined using evidence that inflation and the labor market are cooling, signaling high unemployment and a distressed economy. The Fed will then lower the federal funds interest rate to stimulate spending and hopefully prevent an economic recession.
What happens when interest rates are cut?
When the Fed cuts interest rates, they lower the federal funds target rate, which is the rate banks charge each other. This target rate usually influences the prime rate (the rate banks charge their best customers), causing it to decrease as well. A target range is established by the Federal Open Market Committee (FOMC), and the Fed’s rate is then aligned with that target range.
A reduction in the prime rate can result in an interest rate decrease on variable-rate debt, such as credit cards and home equity lines of credit (HELOCs), and even some mortgage loans. This could potentially impact your finances in the short and long term.
How do interest rate cuts affect your money?
Lowering interest rates typically stimulate the financial markets and push stock prices up with the potential for economic expansion and an outlook of increased profitability. It also impacts businesses favorably by allowing them to borrow at lower costs, which helps to stimulate economic growth through business development and adding employees to the workforce. Some of the benefits Americans can take advantage of when interest rates are cut include:
Lowering your credit card APR
Negotiating a better rate with your credit card issuer.
Investing in the stock market
Investors with excess cash may consider consulting with their financial professional about putting some of it in the stock market. Historically, according to Evercore ISI strategists, the S&P has increased an average of 18% one year after the first rate cut in non-recessionary periods since 1970.
As most investors know, past performance is no guarantee of future results, so there is potential risk that you could not make any money and lose everything. Ensure you consult with a financial professional before making any significant investment decisions.
Zero-interest balance transfer
For borrowers who don’t wish to wait and see if their credit card issuer will negotiate a new rate, they may consider a zero-interest balance transfer credit card. If you struggle with time management and paying bills on time, you must be aware of the risks involved with this type of strategy. If you miss a payment or are late, you could lose your introductory zero-percent rate.
Investing in a high-yield savings account
When the Fed chooses to cut interest rates, Americans can expect rates on money market accounts, certificates of deposit (CDs), and online savings accounts to most likely decrease. However, a high-yield savings account might work for you and your strategy. They may have higher interest rates than other low-risk options, you can access funds relatively easy, and most offer easy online transfers so you can move money quickly and efficiently.
However, be mindful that high-yield savings accounts have variable interest rates, meaning your bank could change your rate at any time. Another risk to be aware of is the potential opportunity cost of losing out on an investment that offers a higher return should interest rates grow stagnant. You may also run into withdrawal restrictions as they don’t tend to offer an ATM card and there may be fees involved, so you want to consider your strategy carefully.
Locking in on a short-term certificate of deposit
Before rates get lowered, some individuals may consider locking in a short-term, maybe one-year top-yielding CD. Keep in mind, this strategy comes with risks, including potentially using money you may need down the road, such as your emergency savings. If you think this may be the case, a high-yield savings account may be the more appropriate option.
Consolidating debts
Some borrowers prefer to consolidate their debts and pay off high-interest credit cards with a lower-rate personal loan. This, of course, has some downsides to keep in mind. When you take out a new loan, your credit score will be impacted, which could affect applications for qualification you recently submitted for other new loans. If you aren’t careful, you could even risk paying more in total interest.
Buying a new home
Pursuing the dream of buying a new house with more purchasing power.
Refinancing
Securing a more sustainable rate for your mortgage or car loan.
Lowering your monthly student loan payments
Consider contacting your student loan servicer and discussing the possibility of changing your repayment plan to one that lowers your monthly payment. This can be beneficial in working to pay down stressful credit card debt. Higher interest rates, however, are not necessarily a bad thing for all Americans. Many banks and credit unions raise their savings rates during stretches of increased interest rates, which benefits some individuals, including retirees living off their savings to generate higher earnings.
Preparation is key
To get a head start on how the rate cuts may impact your financial strategy and goals, consider consulting your financial professional. You may hear about interest rate changes on the news, but it may not be clear how the Fed’s decisions could affect you. A financial professional can help you navigate potential changes and determine appropriate next steps for you to take. When faced with uncertainty regarding potential Fed rate changes, it may help to keep the wise words of Alexander Graham Bell in mind: “Before anything else, preparation is the key.” For more information, contact Ben Fanning by calling (574) 546-1593 or send an email to [email protected].
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Sources:
What Is the Federal Funds Rate? – NerdWallet
What a Fed Rate Cut Could Mean for Your Wallet – Darden Report Online (virginia.edu)
Fed Chair Powell says ‘time has come’ for interest rate cut (nbcnews.com)
The Fed is expected cut rates later this year. What will it mean for your money? | Fox Business
The Fed – Federal Open Market Committee (federalreserve.gov)
Federal spending was responsible for the 2022 spike in inflation, research shows | MIT Sloan
Student Loan Repayment | Federal Student Aid Student Loan Repayment | Federal Student Aid
Federal Funds Rate History 1990 to 2023 – Forbes Advisor
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. All indexes are unmanaged and cannot be invested into directly.
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