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How Does the Fed Rate Cut Affect Me?

The Federal Reserve cut interest rates to nearly zero in March following the coronavirus outbreak. It is the Fed’s way of protecting the economy as well as everyday Americans. You can see this influence everywhere from your mortgage loans to your car payments to your credit card statements.

What Is the Fed Rate?

Understanding the importance of the Fed rate cut means first examining what it is. This information is a little dry, so bear with us. The fed funds rate is the short-term interest rate that banks charge each other to lend Federal Reserve funds overnight.

In a healthy economy, the fed funds rate is 2.0 to 2.5 percent. There are exceptions, though. The Federal Reserve has effectively lowered rates to zero twice. Once was during the 2008 financial crisis. The other was this year in the wake of the coronavirus outbreak. Put another way: the cut in March was nothing short of historic.

The Federal Reserve uses the federal funds rate to maintain an economic equilibrium. It raises or lowers interest rates to maximize employment and stabilize inflation. These actions influence the money supply, starting with banks before trickling down to consumers.

Why Does the Fed Rate Matter?

The current fed rate is almost zero. Who cares? Anyone with a bank account or who borrows money. While the Federal Reserve may feel far-off and nebulous, it impacts you in several ways.

IT MAKES BORROWING MORE ATTRACTIVE

There are pros and cons to the Fed rate cut. If you are looking to borrow money, this is the time to do it. You will typically see lower rates on credit products, such as:

• Adjustable-rate mortgages
• Business loans
• Car loans
• Credit cards
• Home equity lines of credit
• Personal loans
• Private student loans

Let's take credit card rates, for example. Most credit cards have variable interest rates. That means the interest rate changes based on something called a prime rate. The important thing to know is that this underlying rate is tied to the federal funds rate.

Therefore, when the federal funds rate falls, so too do your long-term interest rates on credit cards. From September to December 2019, the Fed cut interest rates three times. According to Bankrate, the average credit rate dipped from 17.8 to 17.36 percent. You can expect to see this reduction in your annual percentage rate (APR) within a billing cycle or two.

One more example.

The Federal funds and mortgages rates are not directly connected. That said, a Fed rate cut benefits people with adjustable-rate mortgages. Homeowners will save money based on the difference between the new and old interest rate. Note that the same benefit does not apply to fixed-rate mortgages.

IT IMPACTS SAVINGS ACCOUNTS AND CDS

When interest rates rise, savers reap the benefits. Because Fed cut rates, though, people's savings accounts get less love. The idea is that low-interest rates will shift incentives from saving money to spending it.

The Fed rate cut affects all interest-bearing accounts. That includes money market accounts, certain checking accounts, and certificates of deposits. For instance, if you are opening a CD, you shouldn't lock in a long-term fixed rate. That way, you can wait until the interest rate goes up and guarantees a better return on investment.

If savings rates are important to you, online banking is an excellent option. These financial institutions can offer higher yields than brick and mortar operations because they have fewer overhead expenses. Therefore, they often pass on better savings rates to their customers.

IT CAN CHANGE YOUR SPENDING HABITS

Hopefully, your dollars do yoga, because the Fed rate cut will require some stretching.

When the Fed lowers interest rates, one of the goals is to increase consumer spending. The goal is to have more people put money into the economy and stimulate growth. This influx of cash is crucial during periods of economic decline when people tend to hold onto money.

If more money is in circulation, though, businesses will likely adjust by raising prices. That means your dollar won't do as far when buying the same things. Simply put: the Fed rate cut extends to your purchasing power and daily spending habits.

The Bottom Line

It’s easy to think of the Fed rate cut as encouraging borrowing and disincentivizing saving. To be clear, it is never a poor time to save. Building your savings is essential to cushion throughout your life.

If you are looking to borrow money, the Fed rate cut is in your best interest. You get lower rates, which reduces the overall cost of borrowing. That applies to everything from starting a business to taking out student loans. While you shouldn't change your spending habits to match the interest rate per se, a Fed rate cut can present opportunities you wouldn't consider otherwise.