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Over the past few years, the Federal Reserve has aggressively raised its benchmark interest rate to a 23-year high to curb inflation. Now that inflation has slowed substantially and is expected to ease further, the central bank is expected to embark on a two-year rate-cutting campaign, starting as early as September.
If so, interest rates would fall on a wide range of financial products for Americans, from credit cards and home loans to bank accounts and certificates of deposit, and more.
Given the many impacts a rate cut can have on your finances, here are some things to consider when deciding what steps to take in response.
Time and magnitude are important
The prospect of lower borrowing costs will be welcome news for those seeking loans or anyone trying to reduce their current debt load. Realistically, though, how much you’ll save when the Fed cuts rates will depend on how quickly it cuts and how much each time. The short-term answer is likely to be “not that much.”
“Interest rates are rising fast, but they will fall fast if they fall,” said Greg McBride, chief financial analyst at Bankrate.
What he meant was: “Interest rates won’t fall fast enough to save you from a bad situation. [this year]“ McBride said. “And for savers, [the initial declines] won’t wipe out your interest income. Savers will still come out on top.”
That’s because one or even two quarter-point rate cuts this year won’t significantly reduce your interest costs. However, several cuts over the next year or two could make a real difference, and it might be worth holding off on taking any action until then.
“Don’t rush into any decisions on this,” says Chris Diodato, a fee-only certified financial planner and founder of WELLth Financial Planning.
Here’s a breakdown of how lower interest rates could impact key areas of your financial life, along with tips from Diodato and McBride on what to do about it.
Getting a mortgage is one of the biggest financial moves most people will ever make. Mortgage interest rates are affected by a number of economic factors, and the Fed’s actions are one of them. Because the loans are so large, this is one area where even a small cut in interest rates can make a significant difference in how much a homebuyer pays.
For those buying a home this year, you may be tempted to buy points to lower your mortgage rate. Before you do, Diodato suggests running some numbers to make sure it will actually save you money if you think you might be tempted to refinance in a year or two if rates drop further. That’s because you’ll pay thousands of dollars to buy points to lower your mortgage rate now, and then thousands more in refinancing costs.
To buy a quarter point might cost you 1% of your loan or 4% for a full point, he said. For refinancing, the cost can be higher — typically between 2% and 6% of your loan, according to Lending Tree.
Given that mortgage rates have fallen at least 1.25% in every rate-cutting cycle since 1971, and often more than 2% or 3%, Diodato sees it this way: “Buying your rate down a quarter of a percentage point, or even a full percentage point, is not going to stop most people from wanting to refinance at some point during the next rate-cutting cycle. So my argument is not to burden people with paying points and then refinancing fees.”
As for taking out a home equity line of credit, know that it’s no longer cheap money to borrow: The current average interest rate range for a HELOC is about 9% to 11%. A few quarter-point rate cuts from the Fed won’t make it much cheaper, McBride says. “Americans have more equity than ever, but you have to be smart about how you tap it, given how expensive it is to borrow. Just because you have equity doesn’t mean it’s free money.”
Of course, if you only take out a HELOC as an emergency lifeline and never tap it, the interest rate may not be as big of an issue. However, you may still end up paying out-of-pocket costs, minimum withdrawal requirements at closing, or other additional costs of having the line, such as annual fees or inactivity fees, McBride notes.
And if you already owe on a HELOC, he advises, “pay it off aggressively. It’s a high-cost debt that’s not going to get any cheaper anytime soon.”
Another form of debt that carries high costs is unpaid credit card balances.S. A few rate cuts won’t make much of a dent in the current average top rate of 20.7%. Even if rate cuts eventually push the average down to where it was at the start of 2022 — 16.3% — those loans will still be expensive.
That’s why, if you have credit card debt, the advice is the same as ever: If you qualify, sign up for a zero-interest balance transfer card that can give you at least 12 to 18 months interest-free so you can make significant strides in paying down your principal.
If that’s not possible, consider transferring your balance to a credit card from a credit union or local bank that offers lower interest rates than the big banks. “They usually have fewer perks, but the interest rates can be half as high,” Dodiato says.
If you’re looking to finance a new car, the rate-cutting environment may not help as much as you might think. McBride notes that each quarter-point cut shaves $4 per month off a typical loan on a $35,000 car. So a full percentage point drop is only $16 per month, or less than $200 per year.
“Your real savings levers are the price of the car you choose, how much financing you apply for, and your credit rating,” he says.
When it comes to car leases, McBride notes, the impact of the Fed’s rate cut may be just as small on the so-called “money factor” you’ll pay for a lease, and because so many variables determine that factor, it can be hard to know the impact of lower interest rates.
Last year was a very good one for anyone who stashed cash in high-yield online savings accounts, many of which paid more than 5% interest. The same goes for those who were able to lock up their cash for a set period of time in certificates of deposit or Treasury bonds, many of which also paid more than 5%.
While those rates will start to fall when the Fed starts cutting rates, the drops likely won’t be huge at first — meaning you’ll still be able to earn more on your savings than the rate of inflation for a while, McBride predicts.
But it may no longer make sense to keep large amounts of cash in these types of vehicles in the future. “I would caution people against getting caught in the cash trap. A lot of people, who are used to good savings rates, are moving money out of stocks and long-term bonds,” said Diodato, who expects savings yields to eventually fall to 3% in the next two years.
Her advice: Don’t keep more than six months to a year’s worth of living expenses in cash or cash equivalents. “Anything more than that will hamper your future net worth,” she says.
That said, McBride suggests that if you’re retiring within five years, you might want to lock in some of the high interest rates still being offered today to grow the cash you’ll need to cover living expenses in the first few years after you leave work. Having that cash on hand won’t force you to withdraw from your long-term portfolio if there’s a major market downturn early in your retirement.
For example, many two-, three-, four-, or five-year CDs currently offer interest rates between 4.85% and 5% on Schwab.com. If you choose a CD with such a long term, try to find one that is not “callable.” Callable CDs are CDs that the issuer can close before their maturity date, which could happen if interest rates fall significantly over the next few years.
“The call feature is ‘Heads I win, tails you lose’ for the issuing bank,” McBride said.
