Understanding the Impact of Federal Rate Reductions on Your Finances

At O1ne Mortgage, we prioritize consumer credit and finance education to help you make the best financial decisions. As we look ahead to 2024, it’s important to understand how projected federal rate reductions could impact your borrowing and savings. Here’s a comprehensive guide to help you navigate these changes.

What Are the Interest Rate Reduction Projections?

The Federal Open Market Committee (FOMC) raised the federal funds rate 11 times between March 2022 and July 2023, holding it steady at a range of 5.25% to 5.5% since then. In December 2023, the committee indicated plans to cut the rate three times in 2024, totaling a 0.75% reduction. Economists expect the first cut to occur in May or June, followed by four more cuts in 2025 and three in 2026, bringing the rate to the 2% to 2.25% range.

These projections are contingent on inflation rates cooling to the FOMC’s target of 2%. The core personal consumption expenditures index, which excludes volatile food and energy prices, showed an annual inflation rate of 2.9% in December 2023.

How Fed Rate Reductions Impact Borrowing

The federal funds rate influences the prime rate, which banks use to set interest rates for various loans, including installment loans and revolving lines of credit.

Installment Loans

For both fixed- and variable-rate loans, the prime rate helps determine the starting interest rate. If you plan on taking out a personal loan, auto loan, student loan, or home equity loan, waiting for Fed rate reductions could save you money.

With fixed-rate loans, further rate reductions won’t impact you because your interest rate is fixed for the life of the loan. However, you could potentially refinance the loan at a lower rate. For variable interest rate loans, such as student loans or adjustable-rate mortgages, your interest rate changes regularly based on market conditions, so you’ll likely benefit from each rate reduction.

Fixed-rate mortgages are indirectly impacted by the federal funds rate but are more influenced by the 10-year Treasury note yield, which is affected by the inflation rate.

Revolving Lines of Credit

If you have a credit card or a home equity line of credit (HELOC), your interest rate is likely variable. This means that both new and existing accounts will likely see interest rates decrease along with reductions in the federal rate.

How Fed Rate Reductions Impact Savings

Banks use customer deposits to fund their loans, and higher loan interest rates often lead to higher interest rates on savings products to encourage more deposits. However, the impact of rate reductions will depend on your bank and the type of account.

Traditional Savings Accounts

Banks offering traditional savings accounts typically don’t offer much higher rates when the federal rate is high. As a result, your rate likely won’t decrease significantly as the FOMC starts cutting rates.

High-Yield Savings Accounts

Banks offering high-yield savings accounts provide annual percentage yields (APYs) much higher than traditional savings accounts. For context, the national average savings rate was 0.47% in February 2024, according to the Federal Deposit Insurance Corp. (FDIC). However, some high-yield savings accounts offer APYs exceeding 4% and even 5%. These accounts offer variable rates, so you’ll likely see your APY decline once the FOMC begins cutting its rate.

Certificates of Deposit

Certificates of deposit (CDs) offer a fixed interest rate, meaning your APY will remain the same for your chosen term, which can range from one month to several years. Once the FOMC starts cutting its rate, you can expect APYs for new CDs to decline. However, if you open a CD before the first rate cut, your fixed rate won’t be impacted, though you can expect a lower rate when it’s time to renew the account at the end of your term.

How to Minimize the Negative Impact of Fed Rate Reductions

If you have some flexibility with your financial plan, there are steps you can take to enjoy the benefits of federal rate reductions while minimizing the drawbacks:

• Hold off on borrowing until interest rates start to decline.
• Look into refinancing existing fixed-rate loans at a lower interest rate.
• Switch to a high-yield savings account to take advantage of higher APYs while you can.
• Consider putting some money in a CD to enjoy a high fixed APY for longer.

The Bottom Line

While economic conditions can influence loan and credit card interest rates, your creditworthiness also plays a major role in securing favorable credit terms. Check your credit score and credit report to evaluate your overall credit health, and consider steps to improve your credit score before applying for a loan or credit card.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. Our team is here to help you navigate these changes and find the best solutions for your financial situation.