The U.S. Federal Reserve on Wednesday reduced its benchmark rate for the third time this year, to a range of 1.5% to 1.75%.
What does the rate cut mean for Americans’ financial wellness? Two members of the American Institute of CPA’s financial literacy commission shared their thoughts.
Neal Stern said the rate cut has implications in several key areas. One is the interest rate people pay on credit cards.
“If you’re paying off a credit card balance, check your statement to see if your card has a variable interest rate, which is likely to decline in response to a Fed rate cut,” Stern said in a commentary.
Lower interest charges can enable the cardholder to pay off the balance faster just by maintaining the same payment as before, since more of the payment will reduce the amount owed.
Stern said now may be a good time to shop around for lower rates, as card issuers can compete for business by passing along the lower rates in balance transfer and other offers. “Be sure to understand the terms and any fees involved.”
Another area in which rate cuts have a notable effect is mortgages and home equity loans, the payments on which may decline.
“That’s a great opportunity to use the savings to increase your 401(k) contribution at work, especially if you’re not already taking full advantage of your employer’s matching,” Stern said.
For those who expect to remain in their home for several years, it may be worthwhile to consider conversion to a fixed rate mortgage, he said. True, interest rates may initially be higher, but the certainty of stable payments without concern about future rate changes can help the homeowner manage a budget and work toward long-term goals.
The interest rate cut can also affect savers. “If your bank lowers the interest rate on your savings account, it pays to shop around, including a look at online banks and credit unions that compete for your funds,” Stern said.
He also suggested investing some of the money — over the amount set aside for emergencies — in a “ladder” arrangement, such as CDs that mature in 6, 12, 18 and 24 months.
Doing this may result in higher rates than standard savings accounts yield, and help protect earnings from future rate cuts, he said. “Be aware of any penalties that may apply if you need to withdraw money before the maturity dates.”
Stern noted that the Fed uses rate changes both to help manage the risks of inflation and as a tool to support the health of the economy. “While we haven’t seen rampant inflation-driven general price level increases in recent years, we’re not immune to escalation that can quickly erode the purchasing power of your savings for retirement and other goals and boost your interest payments on what you owe.”
He said one can manage this risk to financial wellness by paying down variable rate borrowings and maintaining a balance of investments consistent with one’s comfort level, which include assets such as common stocks or mutual funds that can reflect price level changes.
“A qualified financial advisor can help you develop a long-term plan that fits your situation,” he said.
Good News, Bad News
“The rates on any variable debt tied to short-term rates such as the bank prime rate, the T-Bill rate, Libor rates and CD rates will likely be going down,” Monica Sonnier said. “Values may also rise on some fixed income investments such as bonds and mutual funds that hold bonds.”