Fed's first rate cut in more than 10 years: What it could mean for your finances

What the Fed interest rate cut means for your wallet

The Federal Reserve on Wednesday lowered its benchmark federal funds rate by a quarter percentage points to around 2.25% from about 2.5%. The last rate decrease was way back in 2008 — the end of a swift sequence of cuts that had lowered the rate from 5.25% in September 2007 to a lower limit of 0%. Those rate cuts were part of the Fed's aggressive response to an unprecedented global financial crisis that began with the U.S. housing bust in the late 2000s.

Wednesday's widely expected change in Fed policy has generated great debate about whether a rate cut is merited because of the current state of the economy. Supporting the rate cut are data showing the economy losing momentum in areas such as job creation and manufacturing, inflation below the Fed's target, and slowing global growth amid trade tensions.

Contradicting the impetus to cut, the economy is in its longest recorded expansion, unemployment is low and there is ample liquidity at low cost in both consumer and commercial credit markets.

How the Federal Reserve's interest rate cut will affect Americans

Regardless of the reasons or their validity, it is important for consumers to understand the implications of a Fed rate cut on their financial well-being.

Fixed mortgage rates have already declined. There is often a misconception that changes in the federal funds rate affect mortgage rates. Mortgage rates track the 10-year Treasury rate, and both have declined by just over 1 percentage point since November as financial markets anticipated slower economic growth and inflation in 2019. Although the Fed funds and 10-year Treasury rates are often influenced by the same factors, they are rarely impacted to the same extent. In this instance, the declines in longer term rates could be interpreted as contributing to the likelihood of a cut to the Fed funds rate. Thus, a Fed funds cut will likely have little impact on fixed mortgage rates.

The impact will be seen in variable-rate mortgages and home-equity loans. Adjustable-rate mortgages and home equity lines of credit are based on short-term rates. These will be impacted by the decrease in the Fed funds rate, likely declining in tandem.

Credit card debt should become less expensive. Credit card and personal loan interest rates track the bank prime rate, defined as 3 percentage points above the Fed funds target rate. The prime rate will likely move down immediately. However, many credit card contracts do not automatically adjust rates downward. Cardholders should call and ask for lower rates and look for opportunities to transfer their balances.

Auto loans are less influenced by the changes in the Fed funds rate. New cars are often financed by auto manufacturers, with the interest rate part of the car-buying transaction. Lower overall rates in the economy should result in some decline in rates, but this can be overshadowed by other competitive factors, such as manufacturers running 0% financing specials.

Fed chairman Jay Powell thinks wages could be much higher

Rates on deposits could fall. Savers should have been the big winners since the Fed began raising rates in 2015, with nine hikes taking rates to around 2.25% from zero. Many lenders did not fully incorporate increases in the Fed funds rate, but they are more likely to with declines. An interest cut by the Fed may also be the beginning of a series of interest cuts, so it may be a good moment to lock in higher interest rates where available.

The bull market could be extended. The stock market often reacts to changes in the Fed's policy. Financial market expectations are seen by some as a key motivator for the Fed, and stock indices could decline if the central bank does not cut as deeply or as quickly in coming months as many on Wall Street hope. However, incorporating Fed expectations or actions into an investment strategy is not an easy task. A diversified, long-term asset-allocation strategy is the best approach for most investors.

Tendayi Kapfidze is the chief economist for the financial website LendingTree.  

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