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What do changing interest rates mean?

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Published on October 15, 2019
 

Following a decrease in interest rates for the second time in three months, many consumers are left wondering, what does this mean and how do lower rates, especially a lower prime rate, affect me?

When we hear about the Fed’s (federal reserve) decision to raise or lower rates, they are actually adjusting the target rate, also known as the “federal funds rate,” or “nominal rate,” the rate banks charge each other at the end of the day – it helps institutions maintain proper cash levels. This rate is important because other rates, domestic and international, are associated with it and adapt to it.

Officials from the federal reserve’s rate setting committee, the Federal Open Market Committee (FOMC), meet eight times each year to review economic indicators and keep a constant eye on “employment and inflation data.”

In recent months, the Committee has spurred a lot of conversation about economic growth, interest rates, and the overall future of the economy. At the heart of the conversation are potential changes to the prime rate, which ultimately has to do with influencing the price stability of inflation and growth.

The FOMC determines short-term interest rates. When they lower rates, it’s with the intention of stimulating the economy. But, if rates are too low, growth occurs too quickly, inflation occurs, and consumers pay more for items they typically buy, although the true value hasn’t increased. This growth becomes unsustainable, and a shift begins. By raising rates, the Fed can offset this. It’s a delicate balance.

So how do these changes affect you? Six key themes - the good, the bad, and the reality.

Credit Card Rates Decrease

Credit cards rates are commonly tied to the prime rate, meaning the monthly interest rate your credit card company charges each month may decrease.

Good news:
More of your monthly payment will be applied to your balance, rather than interest; you’ll pay off your balance sooner.

Bad news:
For spenders, low balance can que spending! Don’t let a decreasing balance entice you into spending more - pay yourself first! Payoff your credit card, then apply the monthly payment you’re used to making toward building a savings account.

A break for homeowners

It might take a while to notice a difference in your payment, but you might see some relief. Although shifting rates affect second mortgages, first mortgages aren’t typically impacted, they’re influenced by the 10-year treasury yield.

Good News: For the most part, your budget stays stable. And, if the circumstances are right, this could be a good opportunity to take advantage of a home equity loan. Use the equity in your home to pay for a range of things, including, reinvesting in your home to increase the value or paying off debt.

Bad news: It’s easy to withdraw all of the equity in your home! Plan your expenses and stick to it when it comes to spending the equity in your home. Remember, you’ll have to pay back what you spend.

Savings rates may fall

The bad news: If you’re a saver, you probably will not earn as much interest on your savings accounts.

The good news:
This may be a good opportunity to leverage the money you’ve been saving to reinvest in yourself or your home.

Student loan rates could decrease

The good news: Another win for financing your education. When it is time to repay these loans, the majority of your payment will actually be applied to your loan balance, so you’ll pay off the balance more quickly.

The bad news: There are still “private” student loans available. These loans typically have adjustable interest rates, which means although the rate could decrease, it could also increase. Stick to federal funding when possible. 

Lower auto loan rates

The good news: It’s the same as with the other loans, a lower interest rate means you’ll be paying for the car, not for the loan. Plus, if you are happy with your current vehicle, but wouldn’t mind a lower payment, or if it’s paid off, you can refinance your vehicle. There are a few scenarios that are beneficial: You could have a lower monthly payment, maintain your payment but pay your loan off faster, and ultimately, save on the total amount of interest you’ll pay. If your car is even partially paid off, you may have equity to access, meaning you’ll have access to cash.

The bad: Although you’ll be applying more money toward the balance of your loan each month, new car costs continue to soar! Even though you might not be paying a lot in interest, you’re paying a lot for the car. 

Increased costs while traveling abroad

The bad: When our rates decrease, so does the strength of the American dollar compared to foreign currencies.

The good:
There are lots of places in the United States that many Americans have never been. This is a great opportunity to explore National Parks or significant landmarks, or travel someplace you would otherwise never visit. It’s the time to explore.

 

 

Investopedia: https://www.investopedia.com/articles/stocks/09/how-interest-rates-affect-markets.asp

Moneywise: https://moneywise.com/a/interest-rate-cuts-coming-what-it-means
Bankrate: https://www.bankrate.com/banking/federal-reserve/how-fed-interest-rate-decisions-impact-your-money/
Bankrate: https://www.bankrate.com/banking/federal-reserve/how-fed-interest-rate-decisions-impact-your-money/

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