What a Fed Rate Cut or Rise Means for Consumers

The Fed uses the benchmark federal funds rate as an essential tool to either stimulate the economy when it enters a downturn or cool down rapid growth that causes rising inflation. The direction of the fed rates leads other loan rates.

How does the Fed affect loan rates, and what does it mean for consumers in terms of borrowing? We’ll have answers.

 A Lower Fed Funds Rate Is Usually Beneficial For Consumers

A reduced fed funds rate means lower loan and savings rates, so consumers spend more. The fed funds rate is the lending rate for banks and other financial institutions. If you have a lot of debt outstanding, you may feel more relief.

However, the best way to lower your monthly payments is to improve your credit score, which will yield greater benefits.

While we can’t borrow at the fed funds rate, it directly and quickly influences most other interest rates, such as the prime rate, the loan rate charged to the best creditworthy customers. Different consumer borrowing rates are often pegged to the prime rate or Treasury yields.

Two Factors Determine Your APR

The primary consumer financial products are mortgage loans, home equity lines of credit (HELOCs), car loans, credit cards, and student loans. Two essential factors that lenders use to determine your loan’s annual percentage rate (APR). They are:

1. Federal Reserve action to modify the federal funds rate, which is out of our control, and
2. Your credit score, which you can take steps to raise for lower borrowing rates.

What About Savings And Investments?

The savings account rates at banks will likely decline quickly by 25 basis points (one-quarter of a percentage point), matching the Fed’s overnight lending rate for interbank loans.

Our investments in financial securities, notably short and long-term debt and equity securities, tend to move in the opposite direction of interest rates. Therefore, the current markets will start to reflect increases to near-zero fed funds rates. If the next move is a rise in Fed funds rates, that may cause market volatility. 

Lower borrowing rates often mean higher consumer and business spending and, therefore, more robust economic growth. Higher borrowing rates have the opposite effect: consumers slow spending and increase savings because of higher yields at the bank. 

Before we look at how a Fed cut may influence consumer financial products, a little background on the Fed may be helpful.

A Short Primer On The Fed

The Fed (formally known as the Federal Reserve System) is the central bank of the US. They regulate commercial banks and are responsible for conducting monetary policy. Its dual goals are full or maximum employment and stable prices, meaning low inflation.

The Fed uses its tools, notably the federal funds rate, to influence the money supply, credit, interest rates, and the overall US economy through its monetary policy. The fed funds rate is the rate at which banks and other financial institutions lend to each other overnight to meet reserve requirements set by the Fed.

The Federal Open Market Committee (FOMC) votes on raising, lowering, or keeping the fed funds rate unchanged. FOMC members meet at predetermined dates about eight times a year. The voting members of the FOMC are the seven members of the Fed’s Board of Governors, notably Chairman Jerome Powell, plus the Presidents of five Federal Reserve District banks (including the New York Fed).

The Fed affects most aspects of our financial lives.

You should have a working knowledge of what the Fed does, and be mainly interested in all aspects of money and investing.

The Fed, through its monetary policy, influences our economy, borrowing and saving rates, and investments. They play an influential role in controlling the money supply based on economic and inflation indicators, which affect our economy and global markets.

The Fed’s role is multifold:

• As the bank of last resort when other banks are unwilling to lend.
• Assess risk in our economy based on numerous variables.
• A fiscal agent to the US Treasury that supports its securities auctions.
• Model for other central banks globally.
• Communicate publicly to explain their reasoning for their actions.

Mortgages: Fixed Rate or Adjustable Rates

The fed funds are a short-term rate, but fixed-rate mortgages are long-term. When you borrow money to pay for your home purchase, you will likely choose between a conventional fixed-rate mortgage or an adjustable-rate mortgage (ARM). Conventional mortgages are more common. The Fed does set mortgage rates, but its actions may influence the direction of the rates.

Fixed Mortgages

Fixed-rate mortgages are preferable for many home buyers. Your monthly payments are predictable for the length of your loan. Knowing your monthly amounts provides certainty and helps families to budget one of the highest costs.

Generally, 30-year mortgage rates are higher than the 15-year terms because of the longer time frame. Your credit scores will highly influence your rates, and a score of 750+ provides buyers with the lowest rates. I would encourage you to go for the shorter 15-year term, as your total interest paid added to the home price is far lower.

 

Potential For Loan Refinancing

Those with fixed-rate mortgages will not be impacted by the Fed lowering the fed funds rate. However, if the Fed makes more rate cuts in the future, you may want to consider refinancing your mortgage if it makes financial sense for you. Refinancing costs additional fees. When the Fed cut rates to their lowest levels in 2020, there was significant mortgage refinancing, encouraging potential buyers who had been on the fence about searching for a new home.

HELOC Rates Are Variable Loans

Most HELOCs are variable-rate loans. That means that your month-to-month may fluctuate depending on the market interest rate. The benchmark is usually the prime rate. Some banks may offer a fixed rate option for customers who desire predictability and budget their costs. Fixed terms are ten years and may range from 5-15 years.

Your HELOC loan is a credit line secured by the equity in your home and your creditworthiness. As your home serves as collateral, like your mortgage, rates tend to be lower than credit cards. Once again, your credit score matters, along with the Fed rate, which will determine your monthly payments.

How HELOCs Work

You may obtain a line of credit of up to $100,000, but you may draw only $25,000 to pay your contractor. You will only pay interest on the $25,000. This affects your credit score based on your utilization rate.

Generally, you may obtain your HELOC from your existing mortgage lender. It is a convenient way to tap the equity in your home to access credit to remodel your kitchen. A slight reduction in your variable HELOC may help you incrementally.

Car Loan Rates May Change With Fed Action

Most car loan rates are based on fixed terms pegged to Treasury yields. The average loan rate is between 6% to 9% rates on a 72-month loan for new cars, depending on your credit score.   You are not likely to see any improvement in your existing loan rate or monthly payments. However, if you can refinance your car, you may recognize a slight difference in your monthly payments. On the other hand, your loan rate may vary based on three criteria.

1. New or Used Car

You will pay slightly more for a new car loan than for a used car loan or for refinancing an existing loan.

 2. Credit Quality

As with all loans, your credit score matters. Your loan rate may range from excellent or 750+, good or 650-699, or fair to poor at 450-649. Monthly payments may skyrocket if your credit is fair or poor.

3. Loan Term

Term length varies from 36 months to 96 months, with the longer time frame requiring you to borrow to pay the highest rate. You should get to a shorter-term auto loan so you are not shelling out a lot of money on interest. Take the shortest loan term on cars that you can afford. That is a good strategy for any loans you apply for.

The length of the loans has been getting longer and longer. Edmunds says the most common term is for 72 months, with an 84-month loan next in line. I am seeing ads for loans with terms of up to 96 months. That is an increase from 10 years ago, when 60 months were the most common. A longer time frame means you are paying more in total interest cost on your loan.

What You Can Do About Lower Monthly Payments (Or No Payments At All)

Future car buyers may get lower rates following the latest Fed cut. However, your best path to a lower auto loan is to improve your credit score. Better yet, buy a used car outright without a loan. After years of car loans and leases (watch for hidden fees!), we are finally biting the bullet and buying older cars with more mileage for cash. Getting rid of these monthly payments is a longer-term relief.

Credit Card Rates Go Down With Lower Fed Rates

Credit cards carry the highest borrowing rates of most consumer loan products. Their rates are linked to the prime rate, which is quickly influenced by the Fed’s benchmark rate. Interest rates will likely go down as a result of the lower prime rate. Of course, those high rates may not be a problem at all if you pay your card balances in full every month.

Unfortunately, the Fed doesn’t appear likely to be reducing its rates anytime soon. We have seen inflation rising, in part to higher oil prices, but even core inflation has increased in recent months.

Student Loans

Most students rely on federal loans rather than private loans, which are higher for undergraduate and graduate students and their parents. The rates for these loans were tied to the Treasury auction for 10-year notes. We cover this topic in another article. 

Savings And Investing

Savings accounts at banks, including online banks, tend to offer higher rates during periods of rising inflation. These rates have been higher in recent years, particularly after the pandemic, when banks didn’t provide much interest income to savers.  the past.  These accounts did perk up after the rate increases in 2022 enough to merit ads with “high yield savings rates.”

Savings accounts are great for accessibility to liquid funds, such as your emergency money. Money market funds may offer slightly higher rates than savings accounts. They are great alternatives for safety and liquidity purposes. 

The Bull Case For Investing With Low Interest Rates 

Generally, when interest rates fall, consumer and corporate borrowing increase. Lower interest rates may help some segments of our economy, such as industrial companies with high capital budgets. Households may spend more by borrowing when rates are low. However, we are seeing inflation creep upward, and feeling higher prices for groceries and at the pump. High inflation cuts our purchasing power and will likely reduce our spending, pushing the Fed to potentially change its monetary policy