How the Fed's Interest Rate Cut Affects Credit Card, Mortgage, Savings Rates - NBC10 Boston
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How the Fed's Interest Rate Cut Affects Credit Card, Mortgage, Savings Rates

"When the Fed raises or reduces the cost of money, it affects interest rates across the board," said Greg McBride Bankrate's chief financial analyst. "One way or another, it’s going to impact savers and borrowers."

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    How the Fed's Interest Rate Cut Affects Credit Card, Mortgage, Savings Rates
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    The Federal Reserve is the central bank of the United States and is charged by Congress to maintain a stable economy and financial system.

    One of the ways the Fed does this is by increasing and lowering the cost of borrowing money. These interest rate cuts are intended to encourage more borrowing and spending by people and companies. That spending, in turn, tends to accelerate growth and energize economies. Lower mortgage rates, for example, typically lift home sales. And cheaper borrowing can lead businesses to take out loans and expand and hire.

    On Wednesday, the Fed announced it was cutting its benchmark interest rate by one quarter of a percentage point, its second rate cut this year.

    "When the Fed raises or reduces the cost of money, it affects interest rates across the board," said Greg McBride Bankrate's chief financial analyst. "One way or another, it’s going to impact savers and borrowers."

    Here are some ways the Fed cut could impact your wallet:

    How Fed cuts affects credit card, borrowing rates

    Most credit cards have variable interest rates and those are tied to the financial institution's prime rate, which is the rate that banks charge their more creditworthy customers. The prime rate is based on the Fed's benchmark rate, which is the overnight rate banks charge each other to lend money in order to meet mandated reserve levels. When benchmark rates go up, it becomes more expensive for banks to borrow money and they pass those costs on to consumers in the form of higher interest rates on lines of credit.

    A rate cut, meanwhile, could lower interest rates for cardholders and borrowers with variable APRs.

    But with APRs at record highs, Wednesday's .25% cut won't likely offer much relief to people with large credit card balances, says McBride.

    Bankrate.com advises consumers to consider balance transfer card options to pay off their credit card debt. With the fed rate cut, consumers with strong credit scores will have even more access to credit cards offering zero percent interest on balance transfers, Matt Schulz, chief industry analyst for CompareCards.com, told Reuters. Consolidating and paying off your charges within the introductory zero percent APR window is one way to eliminate your debt without interest.

    Will the Fed cuts affect mortgage rates?

    The impact of the Fed rate cut on home loans depends on whether the borrower has a fixed or adjustable-rate mortgage (ARMs), and even then, only slightly. That's because the Fed rate and mortgage rates are not directly linked. 

    A home loan is a long-term financial product, the most common being a 30-year fixed-rate mortgage, while the Fed rate is for short-term overnight borrowing. Long-term mortgage rates are pegged to yields on government bonds, especially the 10-year Treasury note, according to CNBC.com.

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    "I don’t expect that the Fed rate cut will have much of an effect on fixed rates, but it may help support lower rates on ARMs," Lee E. Ohanian, professor of economics and director of the Ettinger Family Program in Macroeconomic Research at UCLA, told BankRate.com. "The 10- and 30-year Treasury rates are still extremely low, even after moving up a bit from last week and those low rates will support relatively low fixed-mortgage rates." 

    Some homeowners with ARMs could eventually see their interest rate go down and lower monthly payments. But that depends on when their rate is scheduled to reset as ARMs only reset once a year.

    Meanwhile, mortgage rates remain at near historic lows. As of last week, the average rate on a 30-year fixed-rate mortgage was 3.56%. A year ago, it stood at 4.6%, according to mortgage buyer Freddie Mac.

    McBride said that this full percentage point difference is "the single biggest impact on consumers" in this low rate environment. Low interest rates on mortgages can open the door for homeowners to refinance and save money or for people shopping for a house to secure an attractive rate. Someone with a $200,000 mortgage could potentially save $125 to $150 a month with a reduction of that size, McBride estimates, which is a meaningful increase in a household budget.

    What about the return on my savings?

    Savers won't benefit from the Fed rate cut. Interest rates on savings accounts were already historically quite low and will likely stay that way.

    The FDIC reports that the average rate paid on savings accounts in the U.S. is 0.09%. While some lenders have been competing online to offer high yield savings accounts with rates well above 2%, a few banks have already opted to dial back those offers. Marcus, the retail bank arm of Goldman Sachs, and Ally Bank both lowered the rates on their savings accounts this spring, just ahead of the Fed's prior rate cut in July. There are still some savings accounts well above the national average available but those rates will likely dip after this most recent announcement.

    All the same, this shouldn't discourage people from saving, McBride said.

    Consumers who find themselves worried about an economic downturn should still take steps now to shore up their finances, regardless of rates. That includes paying down debt, refinancing at lower rates and boosting emergency savings.

    This "will enable households to better weather an economic downturn whenever one should materialize," he said.

    The Associated Press constributed to this report.