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5 ways the Fed's interest rate decisions affect you

Bankrate logo Bankrate 9/18/2019 Sarah Foster

You don't want to hit the snooze button when the Federal Reserve decides to raise or lower rates.

The central bank of the U.S. - also known as the Fed - is charged by Congress with maintaining economic and financial stability. Mainly, it tries to keep the economy afloat by raising or lowering the cost of borrowing money, and its actions have a great deal of influence on your wallet.

Why does the Fed raise or lower interest rates?

The logic goes like this: When the economy slows - or merely even looks like it could - the Fed may choose to lower interest rates. This action incentivizes businesses to invest and hire more, and it encourages consumers to spend more freely, helping to propel growth. On the contrary, when the economy looks like it may be growing too fast, the Fed may decide to hike rates, causing employers and consumers to tap the brakes on their financial decisions.

"When the Fed raises or reduces the cost of money, it affects interest rates across the board," says Greg McBride, CFA, Bankrate chief financial analyst. "One way or another, it's going to impact savers and borrowers."

[READ: How likely is a recession by the 2020 elections? Here's what top economists say]

Officials on the Fed's rate-setting Federal Open Market Committee (FOMC) typically meet eight times a year. They look at a broad range of economic indicators, but most notably, they pay attention to employment and inflation data.

The Fed cut interest rates in July for the first such move in more than a decade, when the economy was facing its worst economic crisis since the Great Depression. Officials cut borrowing costs again at the conclusion of their September meeting. They're worried about a global growth slowdown, weakness in the U.S. manufacturing sector, as well as the ongoing tit-for-tat trade war with China.

Here are five ways that you can expect the Fed to impact your wallet.

1. The Fed affects credit card rates

Most credit cards have variable interest rates, and they're tied to the prime rate, or the rate that banks charge to their preferred customers with good credit. But the prime rate is based off of the Fed's key benchmark policy tool: the federal funds rate.

In other words, when the Fed lowers or raises its benchmark interest rate, the prime rate typically falls or rises with it.

"What the Federal Reserve does normally affects short-term interest rates, so that affects the rates that people pay on credit cards," says Gus Faucher, chief economist at PNC Financial Services Group.

That prime rate, however, hasn't moved in 2019; the Fed has been on hold.

But after the December meeting, when U.S. central bankers voted unanimously to adjust their benchmark interest rate for the fourth time in 2018, the prime rate edged up with it. Leading up to the July rate cut, the prime rate was 3 percentage points higher than the midpoint of the federal funds rate, which was 2.25 percent and 2.5 percent. It typically stays at that level.

2. The Fed affects savings and CD rates

If you're a saver, you most likely won't feel like a beneficiary of a Fed rate cut.

That's because banks typically choose to lower the annual percentage yields (APYs) that they offer on their consumer products -- such as savings accounts -- when the Fed cuts interest rates. For example, banks in June 2019 lowered their yields in anticipation of a rate cut, including Ally and Marcus by Goldman Sachs.

But when and by how much banks choose to lower yields after a rate cut depends on those broader conditions, as well as competition in the space, McBride says. It's also worth remembering that most high-yields savings accounts on the market have annual returns that outpace inflation.

"If the Fed cuts rates, yields will fall, but you're still going to be far ahead from where you were a few years ago," McBride says. "Even if they unwind one of the nine rate hikes that they've made since 2015, the top-yielding accounts are still going to be paying a rate above inflation."

Certificate of deposit (CD) yields generally fall when the Fed cuts rates as well, but broader macroeconomic conditions also have an influence on them, such as the 10-year Treasury yield.

But individuals should focus on the inflation-adjusted rate of return on CDs, says Casey Mervine, vice president and a senior financial consultant at Charles Schwab. In the late 1970s, for instance, yields on CDs were in the double digits; inflation, however, was as well. That means consumers' actual earnings were much lower, due to the erosion of their purchasing power.

If you're worried about a Fed rate cut impacting your returns, consider locking down a CD now.

"Sometimes people start lowering their rates in anticipation of a cut," says Katie Miller, senior vice president of savings products at Navy Federal Credit Union. "That's why I say, if you see some good CD rates, take them."

3. The Fed's influence over mortgage rates is complicated

Mortgage rates aren't likely going to respond quickly to a Fed rate adjustment. Interest rates on home loans are more closely tied to the 10-year Treasury yield, which serves as a benchmark to the 30-year fixed mortgage rate.

That's evident when you look into the past. Each time the Fed has adjusted rates, mortgage rates haven't always responded in parallel. For example, the Fed hiked rates four times in 2018, but mortgage rates continued to edge downward in late December.

But even though the Fed has little direct control over mortgage rates, both end up being influenced by similar market forces, McBride says.

"The 30-year fixed mortgage rate has fallen more than a full percentage point from last year," McBride says. "While not directly related to a Fed cut, the two are sort of a reflection of the same concern: the expectation that the economy is going to slow."

Officials are worried about a slowdown in global growth, as well as ongoing trade tensions and low inflation. Markets in recent weeks have shared those concerns. Yields on the 30-year Treasury note fell to a fresh low and the 2-year, 10-year curve inverted Aug. 14 for the first time since the Great Recession.

It's highly likely that you'll start to see those long-term rates slip lower in tandem with short-term borrowing costs, Miller says.

"It's long-term expectations that tend to dictate where mortgage rates go more than short-term, but even long-term expectations are getting a little bit lower here," according to Miller. "You'll probably see mortgage rates come down as well. The more that comes down, the better off you are, especially if you've gotten you a mortgage in the last couple of years."

That means refinancing could be a smart option for your pocketbook. A reduction in even just a quarter of a percentage point could potentially shave off a couple hundred dollars from your monthly payments.

"Mortgage debt tends not to be high cost; it's just high interest because of the value of the actual mortgage itself," Miller says, "which is why small changes in rates can make a big difference."

4. The Fed impacts HELOCs

However, if you have a mortgage with a variable rate or a home equity line of credit - also known as a HELOC - you'll feel more influence from the Fed. Interest rates on HELOCs are often pegged to the prime rate, meaning those rates will fall if the Fed does indeed lower borrowing costs.

Modest Fed moves, however, likely aren't going to steer those rates in a drastic direction either, McBride says. Leading up to the Fed's rate cut, HELOC rates were still about 2 percentage points higher from where they were a year ago, he says.

5. The Fed drives auto loan rates

If you're thinking about buying a car, you might see slight relief on your auto loan rate. Even though the fed funds rate is a short-term rate, auto loans are still often tied to the prime rate.

It might, however, be a modest impact. The average rate on a five-year new car loan is 4.62 percent, down from 4.72 before the Fed cut rates in July, according to Bankrate data.

Bottom line

When the Fed cuts rates, it's easy to think of it as discouraging savings, McBride says. "It's reducing the price of money. It incentivizes borrowing and disincentivizes savings. Essentially, it gets money out of bank accounts and into the economy." On the other hand, a Fed rate hike discourages borrowing, as the cost of money is now more expensive.

But that doesn't mean it's a bad time to save. Building up an emergency savings cushion, and saving in general, is a prudent financial step.

"Good savings habits are important independent of the interest-rate environment," Miller says. "Your transmission in your car, if it breaks, it doesn't realize if rates are low."

Stay ahead of any Fed rate moves by keeping an eye on your bank's APY. Regularly checking your bank statement can also help you determine whether you're earning a rate that's competitive with other options on the market.

If the Fed looks like it's going to hike rates, paying off high-cost debt ahead of time could create some breathing room in your budget before a Fed rate hike. Use Bankrate's tools to find the best auto loan or mortgage for you.

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