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6/3/2008
The Bottom Line
By Susan L. Smith,
Director of Training & Financial Education
Fed Rate Cut, What it Really Means for You
With the recent historic Federal Reserve rate cuts and stimulus checks on the way, as well as concern about America's economy among foreign markets, many are saying the U.S. has entered a recession. And after all you've heard in the news about the rate cuts, I'm sure a lot of you are wondering what it really means for American families.
When the Federal Reserve cuts interest rates, it is meant to stimulate spending, as well as investments and growth for business. Oppositely, when rates rise, the government is trying to stimulate saving.
So, to break it down for you, the recent rate cuts mean:
Lower corresponding rates on most existing credit cards (not fixed rate, but adjustable rates tied to the Prime or another standard. The Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers)
Lower entry rates on most new credit card accounts
Lower rates on new auto loans
Lower interest rates on home equity lines of credit
Many consumers assume this rate also means lower mortgage rates. This is not necessarily the case. The Federal Reserve rate does not affect long-term treasuries that home loans are based on. That said, rates are falling on mortgages as well, and it is a wise time to see if refinancing would help you save money. Even if you are delinquent on your mortgage due to increased payments on an adjustable rate mortgage (ARM), there are products to help you lock in a fixed rate, and lenders are more willing than ever before to assist you.
Rate cuts often mean a rise in stock prices. This is because reduced borrowing costs for business means greater profit margins, positively influencing stock prices. The stock market has been quite volatile, but the rate cuts have probably saved the market from deeper losses.
How rate cuts affect you:
Lower payments on debt through reduced interest rates or more money being applied to principal
Lower payments on home equity payments
Lower car payments ONLY on new loans (auto loans are set at a fixed rate and would need to be refinanced to achieve a lower monthly payment)
Lower rates with existing creditors (if you have a good credit history and are able to negotiate better rates or open accounts with better terms than you current cards)
In essence, the recent rate cuts should allow you to pay down debts faster. However, the Federal Reserve's purpose of cutting rates is to promote spending in the economy - hoping consumers will use the newly freed-up money to continue to shop and spend.
Who the rate cuts hurt:
Unfortunately, rate cuts hurt savers. Money markets at 5 to 6 percent are gone… CD's too. Interest on money market, passbook and checking accounts is already negligible. If you are retired and living off conservative investment interest income, you will need to review the amount you expect to withdraw on a monthly basis. Keep in mind that saving is different from investing. After these rate cuts, the stock market is more likely to provide a better long-term return than savings accounts.
Regardless of interest rates, everyone should have an emergency savings account to handle the unexpected expenses that pop-up just when you least expect it.
The bottom line - take advantage of the lower rates to refinance your mortgage or apply for a fixed rate credit card not based on Prime.
Susan L. Smith, Director of Training & Financial Education of Consumer Credit Counseling Service of Greater Dallas. You may email her at TheBottomLine@cccs.net.
Thanks to Todd Mark, CCCS Vice-President of Education for his contribution to this article.
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