Recent signs of cooling inflation are paving the way for the Federal Reserve to cut rates when it meets next week, which is welcome news for Americans struggling to keep up with the elevated cost of living and sky-high interest charges.
Consumers should feel good about an interest rate reduction, but it’s important to manage expectations about the immediate relief it may bring. Brett House, an economics professor at Columbia Business School, cautions that while a rate cut is a positive step, it may not deliver sizable immediate relief to consumers.
Inflation has been a persistent problem since the Covid-19 pandemic, with price increases soaring to their highest levels in more than 40 years. In response, the central bank implemented a series of interest rate hikes, bringing its benchmark rate to the highest level in decades.
The spike in interest rates caused consumer borrowing costs to skyrocket, placing many households under financial pressure. However, recent progress on inflation, as evidenced by the Consumer Price Index (CPI) now at 2.5% after peaking at 9% in mid-2022, has given the Federal Reserve the green light to begin cutting interest rates at its upcoming meeting, according to Greg McBride, chief financial analyst at Bankrate.com.
While the first rate cut is expected to be a quarter percentage point, McBride emphasizes that its impact will be minimal. He notes that borrowers can look forward to a series of rate cuts that will cumulatively have a meaningful impact on borrowing costs, but this will take time. Therefore, it’s important to recognize that one rate cut alone will not be a quick fix for financial challenges.
Markets are already pricing in a 100% probability that the Fed will commence lowering rates at its upcoming meeting, with the potential for more aggressive moves later in the year, according to the CME Group’s FedWatch measure. This could potentially bring the Fed’s benchmark federal funds rate from its current range of 5.25% to 5.50% to below 4% by the end of 2025, as predicted by some experts.
Impact on Different Financial Products
As the Federal Reserve embarks on a path of rate cuts, various financial products and services will be affected in different ways. Here’s a breakdown of what consumers can expect in terms of credit cards, mortgages, auto loans, and student loans:
Credit Cards
Most credit cards have a variable rate that is directly tied to the Fed’s benchmark rate. Following the rate hike cycle, the average credit card rate rose from 16.34% in March 2022 to over 20% today, nearing an all-time high. McBride notes that for those paying 20% interest or more on a revolving balance, annual percentage rates will start to decrease when the Fed cuts rates. However, rates are still significantly higher than they were just three years ago, so it may take time for them to fall to more manageable levels.
To address credit card debt, McBride suggests considering a 0% balance transfer credit card and aggressively paying down the balance. Lower rates resulting from Fed rate cuts may not provide immediate relief for high-interest credit card debt, so proactive steps such as balance transfers can be more effective in reducing overall interest costs.
Mortgages
While 15- and 30-year mortgage rates are typically fixed and influenced by Treasury yields and the economy, they are also partly impacted by the Fed’s policy decisions. Home loan rates have already begun to decrease, largely due to the anticipated economic slowdown resulting from potential Fed rate cuts.
As of recent data, the average rate for a 30-year fixed-rate mortgage has dropped to around 6.3%, almost a full percentage point lower than rates in May, according to the Mortgage Bankers Association. However, despite falling mortgage rates, home prices remain high in many areas, limiting the extent to which rate cuts will make purchasing a home or paying off existing debt significantly easier.
Auto Loans
Auto loan rates are also expected to decline in response to Fed rate cuts, but this may not substantially alter the process of car shopping. The average rate on a five-year new car loan currently stands at approximately 7.7%, according to Bankrate.
While lower rates can benefit those seeking to finance a new vehicle, the impact of the next rate cut on loan terms may not be substantial. McBride explains that a quarter-point rate cut on a $35,000 loan translates to around $4 less per month, highlighting that the difference may not be significant for consumers making larger financial decisions like upgrading their vehicle.
Consumers seeking better loan terms may benefit more from improving their credit scores, which can lead to more favorable loan offers and potentially lower interest rates over time.
Student Loans
Federal student loan rates are typically fixed, meaning most borrowers won’t see immediate changes in their rates following a Fed rate cut. However, for those with private student loans, the interest rates may be fixed or variable and tied to rates like the Treasury bill.
When the Fed begins cutting interest rates, the rates on private student loans may decrease as well, potentially offering relief to borrowers with variable-rate private loans. Additionally, borrowers with existing variable-rate private student loans may have the opportunity to refinance into a more affordable fixed-rate loan in the future.
It’s important to note that refinancing federal loans into private student loans may forfeit certain protections and benefits associated with federal loans, such as deferment, income-driven repayment plans, and loan forgiveness options. Extending the loan term through refinancing may also result in higher overall interest costs.
Savings Rates
While the Federal Reserve’s rate decisions do not directly impact deposit rates, changes in the target federal funds rate can influence the yields on savings accounts. Following the Fed’s series of rate hikes in recent years, top-yielding online savings accounts have offered returns well above 5%, with no minimum deposit required.
With rate cuts on the horizon, McBride expects deposit rates to decrease. However, he emphasizes that the key consideration is the return relative to inflation. Despite potential declines in deposit rates, savers can still earn a return that outpaces inflation as long as they choose the right savings vehicle for their financial goals.
In conclusion, while the Federal Reserve’s upcoming rate cuts may offer some relief to consumers in the form of lower borrowing costs, it’s essential to manage expectations about the immediate impact. Financial products like credit cards, mortgages, auto loans, and student loans will see changes in interest rates, but the extent of relief may vary depending on individual circumstances. Proactive financial management strategies, such as debt repayment planning and credit score improvement, can complement the benefits of lower interest rates and help consumers navigate a changing economic landscape effectively.
