Laura reviews smart money moves to improve your finances when the Fed cuts interest rates.
Laura reviews smart money moves to improve your finances when the Fed cuts interest rates.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Due to many issues related to the COVID-19 pandemic, the inflation rate in the United States rose rapidly starting in 2021. In response, the Federal Reserve, or Fed, raised interest rates eleven times from March 2022 to July 2023 to slow down the economy.
In July 2024, inflation dropped to 2.9%, the lowest rate in three years. The last time we saw inflation below 3% was March 2021. But economists say we likely won't see inflation come down to the Fed's target rate of 2% until specific categories, like housing, get less expensive.
Now that the inflation rate is cooling, the Fed is expected to cut rates soon. That will have many downstream consequences for our financial lives. This post will review six money moves you should make with potential interest rate cuts looming.
Hey friends, welcome back! I'm Laura Adams, an award-winning author, money speaker, founder of The Money Stack newsletter, and host of the Money Girl podcast with 43 million downloads. I also work as an on-camera financial spokesperson and partner with select brands for PR and content marketing. As always, you can learn more and email me at LauraDAdams.com.
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How the Fed uses interest rates
The Fed is the central bank of the United States, and it has two primary missions: keeping prices stable for consumers and ensuring a low unemployment rate.
The Fed's lever for achieving those goals is raising or lowering the federal funds rate, which is the interest rate at which banks borrow and lend to one another. That rate trickles down on what consumers pay for debt, like credit cards and loans, or receive on interest-bearing accounts, like savings.
The good news is that when interest rates go down, rates for fixed-rate loans like mortgages, auto loans, and personal loans go down. Debt also gets less expensive for variable-rate products like credit cards, lines of credit, and adjustable-rate mortgages.
The bad news is that you earn less on savings when rates drop. In the past couple of years, we've seen excellent rates, north of 5%, on high-interest savings, CDs, and money market deposit accounts. Since banks follow the Fed's moves, those cushy rates will likely decrease as the federal funds rate decreases. However, it's likely to happen slowly, so there's still time to take advantage of high yields.
6 money moves to make when interest rates drop
With at least one interest rate cut likely in 2024, here are six wise money moves you should make.
1. Watch your savings rate.
If you've been enjoying higher returns on variable-rate, high-yield savings, they can fall even before the Fed cuts their rate based on expectations about what's coming. While you may notice little change with regular savings already paying little, like half a percent, don't be surprised if your high-interest account starts paying less.
Remember that banks and credit unions can change what they pay on savings anytime and may not even notify you that you're earning less. Plus, not all financial institutions react the same way to a cut in the federal funds rate.
Therefore, you should keep a watchful eye on what your savings earn. If you see a significant drop, shop around to find higher-yielding options. You can quickly move your savings to a better account so it earns the most possible interest for you.
I recommend you maintain enough emergency savings to keep you safe in a crisis, such as losing your job or business income or having significant unexpected expenses. A good rule is to keep at least three to six months' worth of living expenses in an FDIC-insured, liquid savings account. That preserves your money and allows you to tap it when needed quickly.
But be sure not to hold too much cash in savings, especially as interest rates decline. Investing excess cash for higher returns is critical so you can reach aggressive financial goals like retirement or paying for college.
RELATED: 7 pros and cons of investing in a 401(k) retirement plan
2. Purchase a certificate of deposit (CD).
As savings rates fall due to interest rate cuts, CDs will also start paying less. However, the upside is that you can lock in today's relatively high interest rates for a set CD term, such as from one to ten years.
Remember that you typically must pay a penalty if you withdraw money from a CD before the end of its term, known as the maturity date. CDs are an excellent place for any excess cash you plan to spend within the next year or two, such as a home down payment.
For instance, if you buy a two-year CD at 5.5%, you'd be happy to earn that much if rates dip significantly over that period. Shop and compare the best CD rates to lock in the highest return on your cash.
Savings is the right place for emergency funds because they offer the most flexibility.
But consider purchasing one or more CDs if you want to earn a fixed, higher interest rate on your cash. They're also an excellent option if you're getting close to retirement or are retired and want to earn as much as possible while keeping your money safe.
The bottom line is that it's an excellent time to lock in some of the highest CD rates we've seen in decades. The chance to earn 5% or more on cash will not last once the Fed starts cutting rates.
LISTEN ALSO: Pros and cons of buying certificates of deposit (CDs)
3. Delay large purchases.
If you're considering a big purchase, like a home or car, waiting could be wise. That's because lower interest rates reduce the cost of financing them, and more cuts could be on the way. However, lower mortgage and auto rates typically boost demand for homes and cars, which could increase their prices.
While you can't perfectly time a significant purchase, when it's possible, try to wait until you see rates coming down. That will make your monthly payments more affordable or allow you to pay a higher purchase price.
4. Consider using home equity.
If you're a homeowner with higher home equity due to housing inflation, tapping it could be an excellent source of funds if needed. You may qualify for a home equity loan or a home equity line of credit (HELOC) for home renovations, debt consolidation, or other purposes.
With interest rate cuts on the horizon, a variable-rate HELOC is a better option than a fixed-rate home equity loan. You can use some or all of your credit line, which will get less expensive if interest rates continue falling. Remember that when interest rates fall, you're better off using variable-rate loans and lines of credit instead of fixed-rate loans.
5. Look into refinancing.
If you bought your home when mortgage rates peaked in 2023, refinancing may be wise as rates decline. If you plan to stay in your home for at least several years, and rates are at least one-half to three-quarters of a percentage point lower than your current mortgage rate, refinancing could be beneficial.
Consider how much money you'd save on a new payment compared to your current payment and the cost of doing a refinance. Refinancing fees could range from 2% to 6% of your new loan amount, depending on your lender and home state. So, get multiple quotes to compare the best refinancing offers.
Refinancing makes sense if your savings exceed the cost over a reasonable period. Plus, if your credit is better now than when you got your mortgage, that could also help you get an even lower interest rate.
6. Maintain good credit.
No matter what happens with interest rates, your credit is a significant factor in how expensive it is to borrow money. So, improving and maintaining good credit always pays off.
Plus, excellent credit scores help you save money in other ways, like paying less for auto insurance, home insurance, and utility deposits. It can also help you get approved to rent an apartment, receive premium offers, and even land a job with an employer that
checks credit.
LISTEN ALSO: 6 ways using credit cards can build excellent credit
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That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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