The Fed, interest rates, and your financial life
Whenever I talk to young people, I tell them that if they remember just one piece of advice, make it this: Start early. Contribute to a retirement savings account as soon as you can. Recently, after I’d given this very spiel, a woman pulled me aside and said that she’d been following the news about the Federal Reserve’s recent interest rate cut—and had read that there may be more to come. Is now still a good time to open a Roth IRA, she asked, or should we wait until we know what’s happening with rates?
Here’s what I told her—and what you need to know about how Fed rate cuts affect other parts of your financial life.
This past July, the Fed cut its rate by a quarter of a percentage point, the first cut in more than a decade—but the market went down that same day. Many analysts explained this drop by pointing to the fact that investors either expected a more dramatic cut, or hoped for clearer indication from the Fed that rates would be cut again soon. So you can see why this is tricky: It’s not just what the Fed does, but what the market expects the Fed to do.
Of course, whether rates are cut by another quarter-point when the Fed meets again this month, as some economists predict, or even a half-point, as others are warning, you can’t let today’s headlines stop you from investing for tomorrow.
Studies have shown it’s virtually impossible to time the stock market.
You’re in this for the long haul, and investments that track the overall market—like the S&P 500—have historically done well over long periods of time despite periodic Fed rate adjustments.
Over the course of 2019, big-name online banks (where you’ll typically find the highest basic savings account rates as compared to traditional brick-and-mortar banks) have gradually decreased their savings rates in response to the Fed’s cut and the overall economic outlook—with some dipping below 2%. If the Fed makes more cuts, we may be entering a very “meh” period for savings rates overall. That said, savings accounts aren’t about high returns. They’re about having a safe and easily accessible place to keep your money for things like your six-month emergency savings fund. For some of the best online bank rates, check bankrate.com or depositaccounts.com.
Mortgage rates are determined by a number of factors—most importantly, the strength of your credit. But when the Fed cuts interest rates, it can also impact some home loans. The most direct way is that adjustable-rate mortgages (ARMs) tend to fall when the Fed rate does too. Still, fewer than 10% of households have ARMs. Much more common are fixed-rate loans, which are not directly impacted by the Fed’s rate cuts. Moreover, since fixed rates are at near-historic lows, it makes sense that people would lock them in now as opposed to getting an ARM in hopes that rates drop even further.
One thing worth considering if you’re hunting for a home is negotiating a free mortgage rate lock—meaning that for a certain period (usually 30 to 60 days, the longer the better) between loan approval and closing, your lender will offer you the agreed-upon fixed interest rate for the life of the loan, even if mortgage interest rates rise during that period. Make sure your rate lock includes a free “float down” option, which allows your rate to decrease if overall rates go down before you close. As always, read the fine print.
If you have credit card debt, you might see a small benefit to Fed rate cuts: Your APR could be going down. Don’t get too excited, though. Credit card rates tend to respond sluggishly to Fed rate adjustments. Plus, a 0.25% decrease is basically meaningless if you have a card that’s collecting 17% interest (that’s about the national average) on your debt. It will make a much bigger difference to look for a lower-rate card to transfer the balance to—or to use some savings to pay it off as quickly as you can. And definitely don’t use any dip in credit card rates as an excuse to go on a spending spree.