How will the latest interest-rate cut affect the average consumer?

How will the latest interest-rate cut affect the average consumer?

How will the latest interest-rate cut affect the average consumer?

Answers to your questions about the news.
Jan. 22 2008 6:39 PM

Will the Interest Rate Cut Affect Me?

Average consumers might notice it, if they have a lot of debt.

Trading floor
Traders at the Chicago Mercantile 

In response to "a weakening of the economic outlook," the Federal Reserve slashed the target for an important interest rate, the Fed funds rate, by three-quarters of a point on Tuesday morning. The move gave some relief to global stock markets, which had taken a dive Friday and Monday on fears of a U.S. recession. But will average consumers see any immediate benefits from the interest rate cut?

Yes. It allows you to buy more stuff, especially if you've got excellent credit and need to borrow lots of money for big-ticket items. Consumers aren't exactly the main focus for emergency rate cuts, which are designed to stimulate the economy and encourage large businesses to spend more. But they do reap the rewards in the long run, and there are some immediate benefits, too. In general, borrowing money—on credit cards or via home and car loans—just got a teeny bit cheaper for many people. You might not notice much of a difference, however, unless you plan to owe—or already owe—a sizable chunk of change.

Advertisement

The Fed funds rate is the rate at which banks lend one another money each night, and it also helps determine all other interest rates. (For more on how the Fed manages the Fed funds target, see this Explainer.) The banks use it to set the prime rate for lending money to their best customers, usually by adding 3 percent. For people who hold credit cards that are tied to the prime rate, today's cut means you'll be paying a smidge less interest on your plastic debts. This is more likely if you've got good credit, but you should check the fine print to be sure. So, if you have a ton of credit card debt, now might be a good time to make a dent in those payments. After the announcement from the Federal Reserve, a slew of banks, including Bank of America, Citibank, and Wells Fargo, also lowered their prime rates by 0.75 percent, to 6.5 percent.

Homeowners might be able to catch a bit of a break, too, but it's less certain because mortgage rates aren't tied to the Fed funds rate. Instead, they're linked to long-term Treasury note yields or another interest rate, the LIBOR, both of which are influenced by the cut. Borrowers who are up this week for the annual resetting of their adjustable rate mortgage will benefit from the cut. This isn't any kind of bailout for subprime borrowers who are in deep trouble, though, since the difference won't diminish their monthly mortgage payments nearly enough to save them from default. As for new house hunters, the relevant Treasury rate had already dropped in anticipation of Fed rate cuts, so this week isn't necessarily that much better for financing a house than last week. But if you can qualify for a loan, you might be able to negotiate better terms.

If the Fed funds rate stays low over the next few years, then consumers might end up dealing with fallout from inflation, since the Federal Reserve generally lowers this key rate by pumping liquidity into the banking system though something called open market operations. In this scenario, savings accounts or retirement accounts that aren't adjusted for inflation will lose value. Poor households and retirees have the most to lose.

Got a question about today's news? Ask the Explainer.

Explainer thanks John Coleman of Duke University and Meghan Crowe of Fitch Ratings.