With the Federal Reserve Bank’s recent interest rate cuts to the federal funds rate, you may be wondering how it will impact your savings rates and loan rates.
Why Did the Federal Reserve Bank Lower Interest Rates?
The Fed made the emergency rate cut to the federal funds rate of a half percentage point (the biggest cut since 2008) on March 3 and another cut on March 15 due to economic concerns from the coronavirus outbreak.
Although the U.S. economy has been strong, lowering interest rates generally helps the economy continue to grow by making borrowing more affordable and encouraging spending.
How Will the Rate Cut Impact Consumer Interest Rates?
Credit cards and loans
If you have a loan with variable interest, your interest charges and monthly payment could be lower due to the rate cut.
Changes to the federal funds rate affects the prime rate – which is the rate used to set interest rates on many variable-rate loan products like credit cards, home equity lines of credit and adjustable rate mortgages.
Once the Federal Reserve lowers the prime rate, it typically takes one or two billing cycles for the Annual Percentage Rate (APR) to be adjusted on your loans.
Deposit rates
Unfortunately for savers, the rate cut by the Fed can also influence savings rates.
Although most savings account rates are not directly tied to the prime rate like variable-rate loans, banks and credit unions typically lower deposit rates – also known as the Annual Percentage Yield or APY – in response to a drop in the prime rate.
Financial institutions earn a large portion of their income based on the difference between the rates they charge on loans (APR) and the rates they pay on deposits (APY) – also known as the interest rate spread.
To maintain this spread, which covers operating expenses (and profit margins in the case of a for-profit bank), banks and credit union must lower how much they pay on deposits.
In a low-rate environment and during times of stock market fluctuations, the best options for savers are Money Market Accounts and Savings Certificates. These accounts typically offer higher rates than a basic savings account because they have higher minimum balance requirements and some restrictions on accessing funds once they are deposited.
With a savings Certificate, your rate is locked in for a set time period or term (e.g., terms from six to 60 months), even if rates continue to fall. While you may redeem your funds before the term is complete, you will most likely be charged an early withdrawal penalty.
Money Market Accounts typically pay less than a Certificate, but you have easier access to the funds without paying an early withdrawal penalty. However, the government restricts the number of monthly withdrawals you can make from a Money Market Account.
Home loans
While mortgage rates are not directly tied to the federal funds rate, mortgage rates can still be affected/lowered due to the Federal Reserve Bank’s rate cut.
If you’re in the market for a new home, locking in a low mortgage rate will give you a lower monthly payment, which means you’ll pay less interest over the life of the loan. In addition, you may be able to afford a larger home when rates are low because your money goes further.
If you have a mortgage with a variable rate or home equity line of credit, you may want to consider refinancing your mortgage to lock-in a lower rate.
Auto loans
If you currently have an auto loan, your rate will not be affected by the Fed’s rate cut since auto loans typically have a fixed APR. However, if you’re shopping for a new or used car, you may see lower auto loan rates.