Discover how a change in the Federal Reserve’s key interest rate can directly impact your wallet, and learn the practical steps you can take to save money.
Decisions made by the Federal Reserve, the central bank of the United States, can often feel distant and abstract. However, its power to change the country’s key interest rate has a direct and tangible impact on the finances of everyday Americans. When the Fed cuts its benchmark rate, it sets off a chain reaction that makes borrowing money cheaper across the entire economy. This can translate into real savings on some of your biggest monthly expenses, especially if you have variable-rate debt.
1. How a Federal Reserve rate cut works.
The Federal Reserve controls the federal funds rate, which is the interest rate at which banks lend money to each other overnight. When the Fed cuts this rate, it becomes cheaper for banks to borrow money. Banks then tend to pass these savings on to their customers in the form of lower interest rates on various consumer loans. This is done to stimulate the economy by encouraging borrowing and spending.
This rate cut directly influences another key rate called the prime rate, which is the interest rate that banks charge their most creditworthy customers. Many consumer loans, especially credit cards and home equity lines of credit, are tied directly to this prime rate. When the prime rate drops, your interest rate on these products often drops as well.
2. Your credit card interest rates will likely go down.
Most credit cards have a variable Annual Percentage Rate (APR) that is directly tied to the prime rate. Your card’s APR is typically calculated as the prime rate plus a margin (for example, prime + 15%). When the Federal Reserve cuts its benchmark rate, the prime rate usually falls by the same amount within a few days. As a result, your credit card’s APR should automatically decrease.
This can lead to lower interest charges on any balance you carry, which can save you a significant amount of money over time. You don’t usually need to do anything to get this lower rate; it should be reflected on your statement within one or two billing cycles. A practical tip is to check your statement after a rate cut to confirm the new, lower APR has been applied.
3. It becomes a prime time to refinance your mortgage.
While existing fixed-rate mortgages are not directly affected by a Fed rate cut, the interest rates for new mortgages are. A Fed rate cut generally leads to lower rates for new fixed-rate mortgages. If the new rates are significantly lower than your current mortgage rate, it could be an excellent opportunity to refinance your home loan. Refinancing means you replace your existing mortgage with a new one at a lower interest rate.
This can result in a substantially lower monthly payment, potentially saving you hundreds of dollars each month and tens of thousands of dollars over the life of the loan. A good rule of thumb is to explore refinancing if you can lower your rate by at least 0.75% to 1%, as this is often enough to offset the closing costs associated with the new loan.
4. Home Equity Lines of Credit (HELOCs) become cheaper to use.
A Home Equity Line of Credit, or HELOC, is a revolving line of credit that is secured by your home. These almost always have a variable interest rate that is tied directly to the prime rate. Therefore, when the Fed cuts its benchmark rate, the interest rate on your HELOC will typically drop almost immediately and automatically.
This makes it cheaper to borrow money from your HELOC for things like home renovations or other large expenses. If you are already carrying a balance on your HELOC, a rate cut will result in a lower monthly interest payment, providing immediate relief to your budget. It’s a good time to check your HELOC statement to see how the rate change has positively impacted your payment.
5. New auto loan rates are likely to decrease.
Similar to mortgages, a Fed rate cut does not affect the interest rate on an existing fixed-rate auto loan. However, it does tend to push down the rates offered for new auto loans. If you are in the market for a new or used car, a lower interest rate environment means you will likely be able to secure a more affordable loan with a lower monthly payment.
For those with an existing high-interest car loan, a rate cut could also present an opportunity to refinance the loan with a different lender at a lower rate. This is particularly relevant if your credit score has improved since you first took out the loan. A simple checklist step is to get quotes from several lenders to see how much you could save.
6. You may be able to refinance your student loans at a lower rate.
Federal student loans have fixed interest rates that are set by Congress and are not affected by Fed rate cuts. However, private student loans are a different story. The interest rates for new private student loans, and for refinancing existing loans, are influenced by broader market conditions, which are affected by the Fed’s policies. A rate cut often leads to a more competitive market for private student loan refinancing.
If you have high-interest private student loans, a lower rate environment could be an ideal time to explore refinancing them into a new loan with a lower interest rate. This could reduce your monthly payment and the total amount of interest you pay over time. It is important to note that refinancing federal loans into a private loan will cause you to lose important federal protections.
7. A key trade-off: Your savings account rates will also fall.
While a Fed rate cut is great news for borrowers, it is less welcome news for savers. The interest rates paid on savings accounts, particularly high-yield savings accounts, are also influenced by the federal funds rate. When the Fed cuts its benchmark rate, banks will quickly lower the Annual Percentage Yield (APY) they offer on their savings and money market accounts.
This means that while you may be saving money on your debt payments, the cash you have in the bank will be earning a lower return. This is a key trade-off to be aware of. A practical tip is to use this opportunity to reassess your financial goals, perhaps by using the money saved on debt payments to pay down your principal balance even faster.