What the Fed Rate Cut Means For You

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3:22Big, big news, money rehabbers. The Fed cut interest rates last week by 0.5%. I mean, it is funny how a small number can be such a big deal. And this is a number that Jerome Powell sweated over. Trust me. But the economy is like a butterfly effect. And half of one percentage point is definitely a big enough wing flab to send huge ripples across the entire economy. Honestly, I think that's why some economists prefer to talk in basis points, which is just a metric in economics that equates to one one hundredth of a percentage point. So in finance speak, Powell just cut interest rates by 50 basis points.

3:58That sounds way more consequential than a 0.5 percent interest rate cut, doesn't it? Anyway, you probably already saw the headline of the Fed cutting interest rates. So this episode isn't some big reveal. Today, I'll be doing what I've done every time the Fed does something major, explaining why it matters and above all why it matters for you. The reason this is newsworthy is because this is the first time the Fed has been able to cut rates since March of 2022, when interest rates started being pulled up to push down inflation. Historically, the Fed tends to move in smaller increments like 25 basis points, just quarters of 1%.

4:35And last week, the big question on Wall Street was whether J-POW would do a 25 basis point reduction or send it with the full 50. By opting for the latter, the Fed sent a strong message of confidence in the health of the economy. The Fed cuts rates for one big reason, to stimulate the economy. Lower rates make it cheaper for people and businesses to borrow money. And when borrowing is cheaper, people tend to spend more. In theory, this boost in spending can help kickstart economic growth during a slow period, like after a recession, something nuts like a pandemic, or any other rough patch. But easy borrowing also tends to put us on a path to inflation.

5:14And well, we know how that story ends. You hear this Goldilocks economy metaphor being used a lot because interest rates are a game of getting the economic activity just right. The target Fed funds rate is 2.9%, and this cut put the Fed funds rate at 4.75 to 5%. So we'll have more rate cuts ahead before we get to what the Fed considers to be that ever elusive just right. So what is this rate cut being for you? Well, like I just said, the Fed funds rate is now between 4.75 and 5%, which is lower than it's been in two years. And this will mean lower rates for you when you borrow money. But to be clear, the Fed funds rate is not our actual rate.

5:55Unfortunately, mortgages are not all of a sudden 4.75%. Even after last week's announcement, mortgages are still on average within the 6 to 6.5 % range. That's because the rate the Fed controls isn't mortgage rates or the APR in your credit card. It's much more specific and distant. The Fed funds rate is the rate a bank will charge another bank when they're doing some short-term lending of money in reserves. But cheaper lending for banks does trickle down to us a bit. So we can expect to see that borrowing is less expensive now than it was two weeks ago, and will continue to get less expensive as rates come down even more over the next year.

6:34So if you're in the market for a home or you're thinking about refinancing your existing mortgage, this rate cut is good news for you. Mortgage rates tend to move in the same direction as the Fed funds rate. But of course, mortgage rates are a bit more complicated than just reflecting the Fed funds rate. But look for an entire episode on that coming up soon. For now, I'll just keep it simple and say yes, a cut by the Fed typically leads to lower mortgage rates. For example, after the Great Recession in 2008, the Fed dropped rates to near zero and mortgage rates followed, eventually hitting record lows around 3%.

7:06This, of course, made it cheaper for millions of Americans to buy homes or refinance existing mortgages. Mortgage rates can take a few weeks or even months to fully respond to a Fed cut depending on factors of the housing market like inventory. Something that does move a little bit more quickly, unfortunately, is shrinking returns for savers. So if you've been enjoying high interest rates on your savings accounts or CDs, brace yourself. When the Fed cuts rates, banks typically lower the interest rate they pay on savings accounts too. This means the money sitting in our high-yield savings account will likely earn us less moving forward.

7:43Historically, after Fed rate cuts, we've seen savings account yields drop within weeks. So what should you do with all of this information? Well, remember, this is supposed to be the first of several cuts. So unless the economy reacts poorly to this first interest rate cut, there's more where that came from. So the thing you'll need to take action on now is locking in a rate on savings vehicles like CDs or bonds before they drop. For today's tip, you can take straight to the bank. Another place you might expect to see your financial load lighten is your credit card bill. Most credit cards have variable interest rates, which means they're tied directly to the Fed funds rate.

8:18So when the Fed cuts rates, your credit card interest rate is likely to drop too eventually. But it's not going to happen overnight unless you press them and ask. With a rate cut, you do have a stronger argument if you want to call your credit card company and ask for a lower APR. It's now easier for your bank to give you a lower rate, but they won't necessarily do it very quickly unless you ask. money rehab is a production of money news network i'm your host nicole lappen money rehab's executive producer is morgan lavoy our researcher is emily holmes do you need some money rehab and let's be honest we all do so email us your money questions money rehab at money news network.com to potentially have your questions answered on the show or even have a one-on-one intervention with me and follow us on instagram at money news and tiktok at money news network for exclusive video content.

9:09And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.