When it comes to loans, the general consensus is that an uptick in interest rates usually means more money out of pocket for borrowers while a decrease means more money in hand. So when the Federal Reserve (the Fed) cuts interest rates, we should all be happy, right? There’s more to dropping interest rates than meets the eye, so it’s important to understand all the factors before making any financial moves.
Why the Fed drops interest rates
In the banking world, the Fed is the central banking system of the United States. It’s the Fed’s job to closely monitor the U.S. market and make any changes necessary to keep financial matters stable. A prime example can be seen with consumer spending. When consumers start spending at a rapid rate, the Fed may act to raise rates in order to curb excess expenses and keep the economy from growing too fast. On the other hand, when spending has slowed, the Fed may lower rates to incentivize more people to spend in order to jump-start the economy. The Fed also takes additional factors into account when considering any interest rate changes, including overall employment, global moves, how the markets are trending and how trade is being handled in other countries.
What happens when the Fed drops interest rates?
Even small changes to interest rates can have a big impact on American wallets, so it’s important to understand what they mean. Many everyday financial products have variable interest rates, and financial institutions often base their prime rates on the federal funds rate set by the Fed. In other words, if you have a product with a variable interest rate and the Fed raises or lowers the federal funds rate, you could see a real monetary change to some of your financial holdings. If, however, you have a product with a fixed interest rate, then changes made at the federal level shouldn’t impact you directly.
How your interest could be impacted
A number of products with variable-rate interest could see changes when the interest rate drops. It might also be a good time to consider making some changes to your current financial products. For example, in some cases, a drop in interest rates could mean more money in your pocket if you’re able to pay less interest on things like:
It’s also a prime time to see if you can lock in a lower interest rate on a new home purchase or get a better rate on your mortgage by refinancing. Although it could take some time for mortgage rates to change after the Fed drops overall interest rates, it’s good to be prepared to make the move if lower mortgage rates do follow.
Credit card rates
Since most credit cards have variable interest rates that are tied to the prime rate, when the Fed lowers rates, you could see those changes reflected in lower credit card interest rates as well. That means you could be paying less interest on existing credit card debt, which would translate into more money in your wallet. If your financial situation allows for it, the time may be right to shop around for a new credit card that offers lower interest or to negotiate for a lower interest rate on your current card.
Although a lowered interest rate generally means positive things for many financial products, there are a few additional things to keep in mind. For example, a lower interest rate at the federal level could unfortunately mean a lower interest rate for your savings account as well. There are, however, ways to avoid the potential negative impact of a lower savings account interest rate. Even though a lower rate would impact almost every type of savings account, learn more about how CDs can help you weather financial ups and downs here.
There’s often confusion when the Fed decides to raise or lower interest rates, as well as some panic, about how it might impact our financial products, and therefore our bottom line. By understanding what exactly a change in interest rate is — and how it might impact specific products — you can be better prepared to make the most of the situation. Rising interest rates means it might also be a good time to look at consolidating some of your accounts at a financial institution that offers relationship-based incentives. No matter what the economic climate, there could be additional savings to be had by doing more with the same business.