How to make the Fed rate cut work for you

(CNN) — The Federal Reserve delivered a half percentage point interest rate cut on Wednesday – its first cut since March 2020.

Wednesday’s move is expected to be the first of several rate cuts over the next year or two. But it alone may not immediately have a big impact on your finances.

For borrowers, “rates are not going to fall fast enough to bail you out of a bad situation,” said Greg McBride, chief financial analyst at Bankrate.com. “And for savers, these rate cuts won’t erase the benefit you got from rising rates in 2022 and 2023. Savers with competitive high-yielding accounts will still be way ahead of the game.”

Here’s how the Fed’s rate-cut move will affect your life, including your credit cards, car loans, home loans, high-yield savings accounts, certificates of deposits and other financial accounts.

Your credit cards

It may take two or three statement cycles before you start to see a lower rate on your credit cards, McBride said.

But given that the average credit card rate is just under 21% — and the average rate on retail store cards is north of 30% — a half point drop may not help much. Even if a sustained rate-cutting campaign over the next two years pushes the average credit card rate to 16.3% — where it was at the start of 2022, before the Fed started hiking rates to beat back inflation — it will still be a pricey loan.

What to do: If you have credit card debt, the advice is the same as it ever was: Pay it off.

Try to get a zero-rate balance transfer card that can buy you at least 12 to 18 months interest free so you can meaningfully pay down the principal you owe. If you can’t secure that, see if you can transfer your balance to a credit card from a credit union or local bank that offers lower rates than the biggest banks. “They typically have fewer perks, but their rates can be half as high,” said Chris Diodato, a fee-only certified financial planner and founder of WELLth Financial Planning.

Your car

Car loan rates are likely to move down fairly quickly in response to the Fed, said Jessica Caldwell, head of insights at Edmunds.com, an online guide to car shopping. In its August survey of car shoppers, a majority (64%) said a Fed rate cut likely would affect the timing of their purchase.

But here’s the thing: Car loan rates are pretty high — the average is 7.1% for new cars and 11.3% for used cars, according to Edmunds. So a half-point drop may not save you as much as you think.

What to do: Every quarter-point cut in your rate knocks $4 a month off a typical loan on a $35,000 car, according to Bankrate. So a full percentage point drop amounts to just $16 a month, or less than $200 a year. “Your real lever for savings is the price of the car you choose, how much you’re financing and your credit rating,” McBride said.

For instance, Caldwell noted, you may think a used car will save you money, but if you’re financing it, do the math. Loans for new cars and certified pre-owned cars often come with subsidized loan incentives, so those incentives coupled with a rate drop might result in better savings than a specific used car loan you’re considering, she said. “Shop the loan. See how much you’ll be paying in total interest (over the loan term).”

Your home

Mortgage rates have already fallen quite a bit in recent months. As of September 12, the 30-year fixed-rate mortgage averaged 6.20%. That’s almost two percentage points below its peak in October.

That’s because mortgage rates are more closely aligned with movements in the 10-year Treasury yield, which typically rises and falls on various economic factors (e.g. inflation, growth, etc.), rather than being directly tied to the Fed’s moves.

McBride thinks further drops in mortgage rates, if they occur, will be more modest over the next year, depending on the health of the economy. “We’re not going back to the sub-3% mortgage rates of 2020 and 2021,” he said.

What to consider if you want to:

Buy a home: Figuring out when to buy a home and what you can afford isn’t just a question of rates. “Other variables like home prices and the availability of homes for sale will be just as important,” McBride noted.

If you do buy a home this year and are considering buying down points to reduce your mortgage rate, crunch some numbers first, Diodato advised. If rates drop further and you think you’ll be tempted to refinance in a year or two, figure out what buying down points will net you in savings, he said. That’s because you will pay thousands of dollars to buy down your mortgage rate now, and then thousands more in fees to refinance.

To buy down a quarter of a point might cost you 1% of your loan or 4% for a full point, he said. To refinance, the costs could be between 2% and 6% of your loan, according to Lending Tree.

Refinance your mortgage: Given where rates already are, if you have a mortgage at 7.25% or more, McBride said refinancing your loan may be worth it if you can get the new rate down to at least 6.25%. That percentage point drop could save you $200 a month on a $300,000 loan. Then calculate how much your refi costs will be to determine how quickly you can recoup them. For instance, if you’re saving $200 a month on a refi, and your refi costs are below $5,000, you can make that back in two years or less.

Get a home equity line of credit: If you want to take out a HELOC, know that it’s no longer cheap money to borrow: Average rates on HELOCs range roughly between 9% and 11%. So a couple of quarter-point rate cuts from the Fed won’t make it meaningfully cheaper, McBride said.

Of course, if the HELOC is meant to serve as an emergency lifeline and you never tap it, the rate may not concern you. But it still may cost you money by way of closing costs, any minimum withdrawal requirements, or an annual fee or inactivity fee, McBride noted.

For those who already owe money on a HELOC, he suggested, “aggressively pay it down. It’s high-cost debt that won’t get significantly cheaper anytime soon.”

Your savings

In the past two years, it was easy for savers and retirees to make a real return (5% or more) on their cash for little to no risk, if they parked their money in high-yield savings accounts and various fixed income vehicles.

The good news: Bank account rates may drop but not so much that you can’t continue to find returns that will handily outpace inflation, which is currently 2.5%, very near the Fed’s 2% target. And competition for deposits among banks mean some will continue to offer attractive returns.

For example, plenty of online high-yield savings accounts at FDIC-insured banks were offering yields between 4.25% and 5.3% on Wednesday, according to listings on Bankrate.com. Such accounts are good for money you’ll need on hand in the next year (e.g. for a big expense or an emergency fund). By contrast, regular savings accounts at big banks could earn you as little as 0.1%.

FDIC-insured certificates of deposit are also still offering inflation-beating returns. At Schwab.com, for instance, CDs ranging in maturities from three months to 10 years were offering rates of between 3.65% and 4.99%.

On short-term Treasury bills with durations of three months to one year, yields were at least 4% on Wednesday morning. On longer-term Treasurys a two-year note was yielding 3.6% while the 10-year offered 3.64%.

What to do if you’re near retirement or have an intermediate term goal: Lock in higher rates now if you’re within five years of retirement, McBride suggests. That way you can grow the cash you’ll need to cover living expenses in the first few years after you stop working. Having that cash on hand means you won’t be forced to pull from your longer-term portfolio should there be a big market downturn at the start of your retirement.

One way to do that is through buying individual CDs or setting up a CD ladder, which lets you allocate savings across CDs of varying durations and reinvests the money when each one matures.

Another option: Create a ladder of high-quality bonds that reinvest every six months to a year, said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research.

Jones thinks that yields on Treasurys, which have fallen recently, may have already priced in lower rates going forward. So you might get better yields on AAA-rated corporate bonds, she said.

For money you need access to in less than three years, Jones recommends putting it in money market funds focused on Treasurys or top-grade municipal bonds; in Treasury bills (with durations of less than two years) or in CDs. For money you won’t need for three to 10 years, you might consider a low-cost bond market index fund or an exchange-traded bond fund that tracks Bloomberg’s Aggregate Bond Index or its US Corporate Bond Index.

Keep the tax bite in mind too. If you live in a high-tax area, and especially if you have a high income, Treasuries might be a better bet than CDs, since they are exempt from state and local taxes. Municipal bonds are typically tax exempt at the state and federal levels, and some are also exempt at the local level, too.

What to do if you’re not near retirement: Reconsider how much money you’re keeping in cash or cash-equivalent investments.

“I caution people against the cash trap. A lot of people, used to these nice savings rates, were diverting money from stocks and longer-term bonds,” said Diodato, who predicts yields on savings will eventually fall to 3% in the next two years.

His advice: Don’t keep more than six months’ to a year’s worth of living expenses in cash or cash equivalents.

“Anything more than that and you’re putting a drag on your future net worth,” he said.

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