The Fed is likely to cut interest rates soon here’s how to boost your savings before then
The Federal Reserve did not lower its key interest rates on Wednesdaywhich have been at a 23-year high for a year. But those responsible continue to signal that the central bank may do so soon – probably in September.
And the market expects that the central bank could cut interest rates further over the next two years. This means that rates should fall on a wide range of financial products, from credit cards and mortgages to bank deposits, fixed-term deposits and bonds, among others.
Given the many ways lower interest rates can affect your finances, here are some things to consider when deciding what steps to take.
Timing and height count
The prospect of lower borrowing costs is welcomed by those looking to borrow or reduce their debt. But realistically, how much you’ll save when the Fed cuts rates depends on how fast it falls and by how much each time. The answer for the near future is likely “not all that much.”
“Rate cuts are like a roller coaster ride,” said Greg McBride, chief financial analyst at Bankrate. “They don’t go up fast enough to get you out of a bad situation, and for savers, it’s still going to be a good deal.”
That’s because one or two quarter-percent rate cuts this year won’t reduce your interest costs by much. But several cuts over the next year or two could make a noticeable difference, and it may be worth putting off some decisions until then.
“Don’t wait too long to make your decisions,” said Chris Diodato, an independent financial planner and founder of WELLth Financial Planning.
Here’s how lower interest rates could affect your finances, plus tips on what you can do about it.
your home
A mortgage is one of the biggest financial moves most people make. Mortgage rates are directly and indirectly affected by several economic factors, and Fed rates are one of them. Since loan amounts are large, even a small rate cut in this area can make a noticeable difference.
For those buying a home this year, you may be tempted to buy points to reduce your mortgage interest. Before you do that, Diodato advises running the numbers to make sure you’ll actually save money if you also consider refinancing again in a year or two if rates continue to drop. That’s because you’ll be paying thousands of dollars now to reduce your mortgage interest, and then paying thousands of dollars again in fees to refinance.
To buy a quarter point, it could cost 1% of your loan, or 4% for a full point, he said. To refinance, the cost could be higher — it’s typically between 2% and 6% of your loan, according to Lending Tree.
Given that mortgage rates have fallen by at least 1.25 percentage points in every rate-cutting cycle since 1971, and often by two or three points, Diodato sees it this way: “Buying a quarter or even a full percentage point off interest would not stop most people from refinancing again during the next rate-cutting cycle. So my recommendation: Don’t burden people with both costs — buying points and the cost of refinancing.”
HELOCs: If you do take out a mortgage line, be aware that it’s no longer cheap money to borrow against: The current average interest rate range for HELOCs is about 9% to 11%. A quarter-percent rate cut or two from the Fed won’t make it noticeably cheaper, McBride said. “Americans are sitting on more equity than ever before, but you should be careful about how you access it when it costs so much to borrow against it. Just because you have equity doesn’t mean it’s free money.”
Of course, a HELOC could serve as an emergency line and never be drawn upon, which could make the interest rate less relevant. But it could still cost you money through origination fees, a minimum withdrawal at closing or other incidental costs to the line, such as an annual fee or an inactivity fee, McBride pointed out.
And if you already have debt on a HELOC, he suggests “paying it down aggressively. It’s expensive credit that’s not going to get cheaper.”
your credit cards
Another perpetually expensive form of debt is your unpaid credit card balance. Some rate cuts will make little difference at today’s record high of 20.7%. Even if they eventually push the average down to where it was at the start of 2022 – 16.3% – it will still be an expensive loan.
That’s why if you have credit card debt, the same advice as always applies: If you qualify, apply for a zero percent balance transfer card, which will give you at least 12 to 18 months of interest-free time to pay off the debt.
If that’s difficult, see if you can transfer your balance to a credit card from a credit union or local bank, which offers lower interest rates than the biggest banks. “They usually have fewer benefits, but their interest rates can be half as high,” Dodiato said.
If you’re considering financing a new car, a rate-cutting environment may not help as much as you think. McBride emphasizes that each quarter-point cut reduces monthly payments on an average loan for a $35,000 car by $4. Therefore, a full percentage point cut is only $16 a month, or less than $200 a year.
“The real lever for savings is the price of the car you choose, the amount financed and your credit score,” he said.
As for leasing a car, McBride found that the impact of a Fed rate cut on the so-called “money factor” you pay on the lease may be just as small. And since many factors affect the size of that factor, it will be difficult to calculate the impact of lower rates.
Your savings
Last year was a very good one for anyone who had cash invested in online money market accounts or various fixed-income securities that yielded 5% or more.
Although these rates will fall – and some have already started – the initial declines probably won’t be very large. That means you can still earn inflation-beating returns for some time.
For example, many online money market accounts still offer interest rates between 4.5% and 5.2%, as Bankrate reports. This also applies to fixed-term deposits.
Treasury bonds with maturities between two and ten years are yielding more than 4%, Schwab.com reports.
Secure high interest rates now: If you are within five years of retirement, McBride suggests locking in some of those still-high-interest savings to grow the cash you will need to cover living expenses in the first few years after you stop working. Having that cash means you won’t be forced to retire at a large Stock market crash at the beginning of your retirement access your long-term portfolio.
For example, many CDs with terms of two, three, four or five years currently pay between 4.85% and 5% on Schwab.com. If you choose one of these terms, try to find one that is not “callable.” A callable CD is one that the issuer can close before the maturity date, which could happen if interest rates drop significantly in the next few years.
If you live in a high-tax area, Treasury bonds may be a better choice because they are exempt from federal taxes.
“Although many bond yields have fallen from their recent highs, investors should still consider making some medium- to long-term investments now before rates are cut if they want to lock in a higher yield on some of their money, such as Treasury bonds maturing in the next four to 10 years,” said Collin Martin, a fixed income strategist at the Schwab Center for Financial Research.
And AAA-rated municipal bonds are exempt from federal taxes and, in some cases, state and local taxes as well. Yields for AAA munis with maturities between one and five years range from 3.2% to 4.19%.
But don’t keep too much cash: For people who are not planning to retire any time soon, it may no longer make sense to keep so much cash in these investments.
“I warn against falling into the cash trap. Many people who are used to these good savings rates have shifted money away from stocks and long-term bonds,” said Diodato, who predicts that interest rates on savings will fall to 3% in the next two years.
His advice: Don’t hold more than six months to a year of cash or cash equivalents.
“Anything beyond that puts a strain on your future net worth position,” he said.
The central bank’s potential rate cuts could lead to a reduction in interest rates on various financial products, including mortgages. This reduction may not be significant in the near future, but several cuts over the next year or two could make a noticeable difference.
For those with credit card debt, the initial impact of a Fed rate cut likely won’t be significant, given the high average rate of 20.7%. However, if you qualify, a zero percent balance transfer card could help you service your debt.
