As I begin this post, I want you to know that it is not intended to be a complete primer on interest rates and their impact on your finances. It is being written to summarize the impact of our current low interest rates on your financial life.
In December 2019 The Federal Reserve (The Fed) offered an upbeat view on the economy and indicated it doesn’t expect to raise interest rates again for at least another year unless the economy changes dramatically. It kept its benchmark rate for what is called federal funds in a range of 1.5% and 1.75%. This rate forms the basis for the interest rates you pay on loans and receive on deposits. The Fed had cut U.S. interest rates in three successive meetings starting in July 2019. So this action has left us with the expectation that our current low level of interest rates will stay in place for 2020. The Fed has kept interest rates low to stimulate economic growth. Lower financing costs can encourage borrowing and investing.
What Does This Mean to You?
Consumers pay interest on borrowings based on rates that are set based on the Fed’s actions. The recent rate cuts should help consumers save money by reducing interest payments on borrowings. Below are the major types of loans and financial assets and the impact of lower rates.
If you borrowed money to attend college, you most likely won’t feel any major impact from lower rates and the Federal Reserve’s interest rate cuts. That’s because most of the 45 million Americans with student loan debt have fixed interest rates, meaning the amount they pay is locked in for the life of their loan. Even then, the majority of borrowers have federal student loans, and Congress determines those interest rates, not the U.S. central bank. If you have a student loan with a variable interest rate, you could see a slight relief in your payments.
The rate cuts have proven beneficial in lowering the costs of home financing, but the impact depends on what type of mortgage you have, whether fixed or variable, and which rate the mortgage is linked to. For fixed-rate mortgages, a rate cut will have no impact on the amount of the monthly payment. Low rates can be good for potential homeowners, but fixed-rate mortgages do not move directly with the Fed's rate changes. A Fed rate cut changes the short-term lending rate, but most fixed-rate mortgages are based on long-term rates, which do not fluctuate as much as short-term rates. Generally speaking, when the Fed issues a rate cut, adjustable-rate mortgage (ARM) payments will decrease. The amount by which a mortgage payment changes will depend on the rate the mortgage uses when it resets.
The impact of lower rates on credit cards depends on whether the credit card carries a fixed or variable rate. For consumers with fixed-rate credit cards, a rate cut usually results in no change. Many credit cards with variable rates are linked to benchmarks where a federal funds rate cut will typically lead to lower interest charges. It is important to remember that even if a credit card carries a fixed rate, credit card companies can change interest rates whenever they want to, as long as they provide advanced notice (check your terms for the required notice).
When the Fed cuts interest rates, consumers usually earn less interest on their savings. Banks will typically lower rates paid on cash held in bank accounts of all types. The rate cut usually takes a few weeks to take effect. Overall, rates on savings products have increased over the last several years but still remain historically low.
CDs and Money Market Accounts
If you have already purchased a bank certificate of deposit (CD), there is no need to worry about a rate cut because your rate is locked in. But if you plan to purchase additional CDs, a rate cut will result in new, lower rates. Deposits placed into money market accounts (MMA) will see similar activity.
Retirement and Retirement Savings
With lower rates of interest on savings you will need to carefully look at your plans for saving and accumulating funds for later in life. With lower expected returns, you may need to save more now to have the pot of money you desire when you plan to stop full-time work.
The Overall Impact on Your Cash Flow
The Federal Reserve uses its target federal funds rate as a monetary policy tool and you need to understand what the current rates are. The impact of any change the Fed makes depends on whether you are a borrower or a saver. You need to know the details of any financing and savings arrangements you have in place so that the next time the Fed changes interest rates, you will know exactly what the change means to your wallet.
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