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The Federal Reserve, a.k.a. the Fed, was in the news for more than a decade for raising the federal funds rate. But the headlines have changed. In July 2019 the Fed finally cut its benchmark interest rate. The Fed raises or lowers the federal funds rate to influence the direction of the U.S. economy toward strong employment and stable inflation.
Alright, this may all seem pretty high level. It’s just a bunch of news for policymakers, economists and investors playing the market. Right? Not so fast. While it may sound like a fancy finance term, the federal funds rate is the interest rate banks charge each other to lend funds overnight. When that rate goes down (or up), the effects trickle down to you and the financial products you use every day—think credit cards, loans and savings accounts.
Even if you don’t typically follow financial headlines, understanding what happens when the Fed lowers rates can help you make smart financial decisions when it comes to borrowing, saving and spending. Read on to answer the question: What does a Fed rate cut mean for my finances?
What happens when the Fed lowers rates? One of the Fed’s goals with a rate cut is to make borrowing less costly. Translation: You could see lower interest rates on credit.
Economist and podcast host John Norris says that a Fed rate cut could actually be helpful to the average consumer. “If history serves as a guide, the prime rate will fall by the same amount as the Fed’s actions,” Norris says. “This means credit cards and home equity lines of credit (HELOCs) will be a little cheaper for consumers moving forward.” The prime rate, which is based on the federal funds rate, is the interest rate lenders charge their most creditworthy customers.
Broken down simply, here’s how a lower Fed rate impacts you and the various types of credit you may already have or be considering:
Now, what does a Fed rate cut mean for my finances when it comes to saving? Savers could see interest rates decline on deposit accounts like savings accounts, money market accounts and certificates of deposit (CDs). A lower interest rate here means you’ll earn less in interest on your savings balances.
“Banks make money by making a spread between what they pay for deposits and what they charge on loans,” Norris says. “When what they can charge on a loan goes down, it makes sense what they pay on deposits will eventually do so as well.”
“If history serves as a guide, the prime rate will fall by the same amount as the Fed’s actions. This means credit cards and home equity lines of credit (HELOCs) will be a little cheaper for consumers moving forward.”
What does a Fed rate cut mean for my finances is only half of the puzzle. The other half is determining how to manage your finances in a lower rate environment so you can achieve your financial goals. Follow these tips when you consider how a lower Fed rate impacts you for borrowing, saving and spending:
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“When it comes to spending, lower interest rates can encourage bigger purchases, such as home improvements, cars and homes. But before making a big-ticket purchase, make sure you have a budget so you can see how the purchase will affect your monthly cash flow.”
Even if financial news isn’t your thing, paying attention to trends like a Fed rate cut (or hike) can help you manage your money most effectively. Despite the interest rate climate, though, it’s still important to remain disciplined in your financial strategy. This includes setting financial goals, creating a plan to reach them and educating yourself on tools and methods that can help you in the process. Whether interest rates are low or high, you’ll always win with this approach.
* This should not be considered tax or investment advice. Please consult a financial or tax advisor if you have questions.
1 The Annual Percentage Yield (APY) for the Online Savings Account as of 08/01/2020 is more than five times the national average APY for interest-bearing savings accounts with balances over $500 as reported by Informa Research Services, Inc. as of 08/01/2020. Interest rates and APYs are subject to change at any time. Although the information provided by Informa Research Services has been obtained from the various institutions, accuracy cannot be guaranteed.
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