The Federal Reserve’s decision to cut interest rates may mean cheaper loans for most Americans. At the same time, consumers will earn less interest on their savings.
The Federal Reserve’s decision to cut interest rates by a quarter point for the third time this year is meant to bolster the economy.
Everyday Americans may lose some ground.
On the one hand, lower rates often mean cheaper loans, which can impact your mortgage, home equity loan, credit card, student loan tab and car payment.
However, borrowers may not get the full benefit if the economy is weakening, as the Federal Open Market Committee and Chairman Jerome Powell have suggested it is.
In anticipation of an economic slowdown, lenders are less inclined to lend money and may even charge a higher interest rate to hedge against the risk, according to Richard Barrington, a financial expert with MoneyRates.com.
Consumers also likely will earn less interest on their savings accounts and, in some cases, lose buying power over time.
“In this case, a Fed rate cut would not be very good” for savers or borrowers, Barrington said.
Here’s a breakdown of how it works:
For starters, the prime rate, which is the rate banks extend to their most creditworthy customers, is typically 3 percentage points higher than the federal funds rate. That not only determines your savings rate, it also is the rate used for many types of consumer loans, particularly credit cards.
With a rate cut, the prime rate lowers, too, and credit cards likely will follow suit. Most credit cards come with a variable rate, which means there’s a direct connection to the Fed’s benchmark rate.
As a result, cardholders could see a reduction in their annual percentage rate within a billing cycle or two. Considering the average household owes $8,602, that will save credit card users roughly $1.6 billion in interest, according to an analysis by WalletHub.
However, credit card debt will continue to be expensive, with APRs still only down slightly from all-time highs.
A quarter-point decrease from around 17.5% saves someone making minimum payments toward the average debt about $1 a month, according to Ted Rossman, industry analyst at CreditCards.com.
“A quarter of a percent decrease isn’t going to rescue anyone,” said Sara Rathner, a credit card expert at NerdWallet.Better yet, shop around for a zero-interest balance transfer offer and “transfer your existing high-rate credit card debt to a new card with no interest while you still can,” Rossman advised. If the economy continues to soften, these terms could get less generous, he said.
At any time, cardholders can also reach out to their issuer directly to request a break on interest rates.
Savers only recently started to benefit from higher deposit rates— the annual percentage yield banks pay consumers on their money — after those rates hovered near rock bottom for years. After another rate cut, those rates likely will slip back to near zero.
Because the central bank raised the federal funds rate nine times in three years, the highest-yielding accounts are now paying more than 2.25%, up from 0.1%, on average, before the Fed started increasing its benchmark rate in 2015.
“The one piece of good news is that there’s a huge disparity between top bank rates and average rates,” MoneyRates’ Barrington said. With an annual percentage yield of 2.25%, a $10,000 deposit earns $225 after one year. At 0.1%, it earns just $10.
Still, nearly 7 in 10 Americans earn less than 2%, according to a survey by Bankrate.
Such low interest rates have cost depositors $1.5 trillion in purchasing power in the decade since the Great Recession, according to Barrington.
Online banks are typically able to offer the highest yields because they come with fewer overhead expenses than traditional bank accounts and savers can snag significantly higher savings rates by shopping around.
“If it means the difference between staying ahead of inflation and losing purchasing power, it’s worth it,” Barrington said.
Alternatively, consumers can lock in a higher rate with a one-, three- or five-year certificate of deposit (top yielding rates average 2.3%, 2.5% and 2.75%, respectively) although that money isn’t as accessible as it is in a savings account and, for that reason, does not work well as an emergency fund.
Federal funds and mortgage rates are not directly linked. Rather, the economy, the Fed and inflation all have some influence over long-term fixed mortgage rates, which generally are pegged to yields on U.S. Treasury notes.
Mortgage rates have already been declining for almost a year, noted Tendayi Kapfidze, chief economist at LendingTree, an online loan marketplace, with the average 30-year fixed rate now just under 4%, according to Bankrate.
“Mortgage rates this low at the end of an economic cycle is nearly unprecedented, and may be very well keeping the housing market — and U.S. economy — afloat,” said Ralph McLaughlin, deputy chief economist and executive of research and insights for CoreLogic.
That makes this a good time to refinance at a lower rate, which would save the average homeowner about $150 a month, according to Greg McBride, chief financial analyst at Bankrate. “The refinancing window is still wide open,” he said.
Many homeowners with adjustable-rate mortgages, which are pegged to a variety of indexes such as Libor or the 11th District Cost of Funds, may see their interest rate go down as well, although not immediately because many ARMs reset just once a year.
The Fed’s third consecutive rate cut will also make it slightly cheaper for consumers to borrow money from a home equity line of credit — a popular way for homeowners to pay for renovations and repairs — or pay back their current HELOC loan. Unlike an ARM, HELOCs could adjust within 60 days, so borrowers will benefit from smaller monthly payments within a billing cycle or two.
For those planning on purchasing a new car, the Fed decision likely will not have any big material effect on what you pay. For example, a quarter-point difference on a $25,000 loan is $3 a month, according to Bankrate.
Auto loan rates have remained low, even after years of rate hikes. Currently, the average five-year new car loan rate is 4.61%, up from 4.34% when the Fed started boosting rates, while the average four-year used car loan rate is 5.34%, up from 5.26% over the same time period, according to Bankrate.
However, since new cars are often financed by car manufacturers, this rate cut will lower their costs, as well, and could mean car shoppers will see more favorable rates to come, Kapfidze said.
Other factors will also play a role in the overall cost of a car in the months ahead, including increased tariffs on materials.
While most student borrowers rely on federal student loans with fixed rates, more than 1.4 million students a year use private student loans to bridge the gap between the cost of college and their financial aid and savings.
Private loans may be fixed or may have a variable rate tied to Libor, prime or T-bill rates, which means that when the Fed cuts rates, borrowers will likely pay less in interest, although how much less will vary by the benchmark and the terms of the loan.
If you have a mix of federal and private loans, consider prioritizing paying off your private loans first or refinance your private loans to lock in a lower fixed rate if possible.
(A college education is now the second-largest expense an individual is likely to incur in a lifetime — right after purchasing a home. The average graduate leaves school $30,000 in the red, up from $10,000 in the early 1990s.)