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Over the past two years, the Federal Reserve has aggressively raised its benchmark interest rate to 23-year highs to combat inflation. Now that inflation has slowed significantly and is expected to decline further, the central bank is expected to embark on a campaign of rate cuts over the next two years, starting in September.
If so, rates should fall on a wide range of financial products for Americans, from credit cards and home loans to bank accounts and certificates of deposit, among others.
Given the many ways low rates can affect your finances, here are some things to consider when deciding what steps to take in response.
Timing and magnitude matter
The prospect of lower borrowing costs will be welcome news for those looking to get a loan or trying to reduce their current debt. But the reality is that how much you save when the Fed cuts rates will depend on how quickly it does so and how much each cut is. The short-term answer is probably “not that much.”
“Interest rates took the elevator up, but they’ll take the stairs down,” said Greg McBride, chief financial analyst at Bankrate.
By that he means: “Rates aren’t going to come down fast enough to get you out of a bad situation (this year),” McBride said. “And for savers, (the initial declines) aren’t going to wipe out their interest income. Savers are still going to be ahead of the curve.”
Indeed, one or even two quarter-point rate cuts this year won’t significantly reduce most of your interest costs. But several cuts over the next two years could make a noticeable difference, and it may be worth delaying some measures until then.
“Don’t rush into this stuff too early,” said Chris Diodato, a fee-only certified financial planner and founder of WELLth Financial Planning.
Here’s a breakdown of how lower rates can affect key areas of your financial life, along with advice from Diodato and McBride on what to do about it.
Getting a mortgage is one of the most important financial decisions most people make. Mortgage rates are influenced by a number of economic factors, and the Fed’s actions are one of them. Since the loan amounts are substantial, this is an area where even small interest rate cuts could make a significant difference in how much a homebuyer will pay.
For those buying a home this year, you may be tempted to buy back points to lower your mortgage rate. Before you do, Diodato advises, do some math 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 back your mortgage rate now, and then thousands more in fees to refinance.
According to him, buying back a quarter point can cost you 1% of your loan or 4% for a full point. To refinance, the costs can be higher: They typically range from 2% to 6% of your loan, according to Lending Tree.
Given that mortgage rates have fallen by at least 1.25% in every rate-cut cycle since 1971, and often by more than 2% or 3%, Diodato sees it this way: “Lowering your rate by a quarter of a percentage point, or even a full percentage point, would not prevent most people from wanting to refinance at some point during the next rate-cut cycle. So my thinking is not to burden people with both the point payment and the costs of refinancing.”
As for taking out a home equity line of credit, it’s not cheap money anymore: The current average rate range for HELOCs is about 9% to 11%. A few quarter-point rate cuts from the Fed won’t make that rate significantly cheaper, McBride said. “Americans have more equity than ever, but you have to be smart about how you tap into it, given the cost of borrowing. Just because you have equity doesn’t mean you’re getting free money.”
Of course, if you take out a home equity line of credit solely as an emergency lifeline and never draw on it, the rate may be less of a concern. But it can still cost you money in terms of closing costs, minimum withdrawal requirements at closing or other incidental costs associated with the line of credit, such as annual fees or inactivity fees, McBride noted.
And if you already have a home equity line of credit to pay off, he suggests “paying it off quickly. It’s a high-cost debt that’s not going to go down anytime soon.”
Another form of perpetually costly debt is your outstanding credit card balance.m. A few rate cuts won’t be enough to significantly reduce the current record average rate of 20.7%. Even if the rate cuts eventually bring the average rate back to where it was in early 2022 (16.3%), borrowing will still be expensive.
That’s why, if you have credit card debt, the advice remains the same: If you qualify, sign up for a zero-interest balance transfer card that can give you at least 12 to 18 months of interest-free time so you can significantly pay off the principal you owe.
If that proves difficult to obtain, see if you can transfer your balance to a credit card from a credit union or local bank that offers lower rates than the larger banks. “They typically offer fewer perks, but their rates can be half as good,” Dodiato said.
If you’re looking to finance a new car, lower interest rates may not help you as much as you think. McBride notes that every quarter-percentage-point decrease cuts $4 per month from a typical $35,000 car loan. So a one-percentage-point decrease works out to just $16 per month, or less than $200 per year.
“Your real savings lever is the price of the car you choose, the amount you finance and your credit score,” he said.
When it comes to leasing a car, McBride noted, the effect of a Fed rate cut could be similarly small on the so-called “money factor” you’ll pay for the lease, and since many variables determine what that factor will be, it will be difficult to determine the impact of lower interest rates.
The past year has been a very good one for anyone who has put their money into high-yield online savings accounts, many of which have returned more than 5%. The same goes for those who have been able to lock their money away for periods of time in certificates of deposit or Treasury bills, many of which have also returned more than 5%.
While those rates will start to fall when the Fed starts cutting rates, the cuts likely won’t be huge at first, meaning you’ll still be able to earn more on your savings than the inflation rate for a while, McBride predicts.
But it may not be wise to leave so much cash in these types of vehicles in the future. “I caution people about the cash trap. A lot of people, used to these attractive savings rates, have shifted their money away from stocks and long-term bonds,” said Diodato, who predicts savings yields will eventually fall to 3% within the next two years.
His advice: Don’t keep more than six months to a year of living expenses in cash or cash equivalents. “Anything more than that can reduce your future net worth,” he said.
That said, McBride suggests that if you’re less than five years away from retirement, you might want to lock in some of the high rates still available today to grow the money you’ll need to cover living expenses in the first few years after you stop working. Having that money on hand means you won’t be forced to dip into your long-term portfolio if markets take a big downturn early in your retirement.
For example, many two-, three-, four- and five-year CDs are currently yielding between 4.85% and 5% on Schwab.com. If you’re looking for a longer-term CD, try to find one that isn’t “callable.” A callable CD is one that the issuer can decide to close before its maturity date, which could happen if rates drop significantly in the next few years.
“The call feature is a ‘heads I win, tails you lose’ for the issuing bank,” McBride said.