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Financial markets have largely cheered the dawn of a lower interest rate environment, as the Federal Reserve responds to falling inflation. How lower rates will affect your wallet, however, depends entirely on whether you are a borrower or a saver.
The central bank, which controls monetary policy, began raising its benchmark federal funds rate in 2022 to combat surging inflation following the Covid-19 pandemic, it’s fastest series of rate hikes in 40 years. Inflation measures how quickly the price of goods and services are climbing.
It appears to have worked, as inflation fell in 2024, prompting the Fed to begin a rate cutting campaign in late 2024 to stimulate growth. And while there are still questions about how fast and far the Fed will continue cutting, it appears that generally interest rates are on a downward trend.
How interest rates affect consumers
The federal funds rate is the interest rate that commercial banks charge each other for short-term (overnight) loans.
Changes to the federal funds rate impact consumers indirectly.
Commercial banks and credit unions use it to set their own prime rate, which is the interest rate they charge their best borrowers (based on credit rating) for new loans, including home and auto, personal, and small-business loans.
The prime rate also affects existing loans with a variable annual percentage rate (APR), including adjustable-rate mortgages (ARMs), home equity lines of credit, and most credit card balances.
Thus, the federal funds rate influences the prime rate, which, in turn, sets the basis for what interest rate banks charge borrowers for loans — or pay savers for deposits.
Borrowers
When interest rates fall, it makes it cheaper for businesses and consumers to borrow money to pay for things like office equipment and new cars. In an ideal world, increased spending serves to strengthen corporate profits, which propels stock market returns and economic growth.
Lower interest rates can potentially reduce the monthly payments for:
- Home mortgages
- Home equity loans and lines of credit
- Credit card balances
- Auto loans
- Student loans
Home mortgages
Lower interest rates make it more enticing for renters to buy a home, which helps to fortify housing market growth.
It’s important to note that interest rate fluctuations only impact new borrowers and those with existing variable rate debt, such as adjustable rate mortgages (ARMs), home equity lines of credit, and credit card balances. Homeowners with a current fixed rate mortgage, for example, would not be affected by interest rate changes.
That said, existing homeowners may be compelled to refinance their current mortgage when interest rates fall, which could amount to a lower monthly payment. That’s particularly true for those who still have an adjustable rate mortgage and wish to lock in a lower rate. (Learn more: How to refinance your mortgage)
“For those with cash available, this may be a good time to refinance their mortgage to lock in a better rate,” said Terrell Joyner in an interview, a MassMutual financial professional with Unity Financial & Insurance Group in Holyoke, Massachusetts. (Related: 3 perspectives on market volatility)
However, homeowners should review their loan package carefully, Joyner suggested. Those lower monthly payments may look much better, but it’s often because they’ve refinanced to a new 30-year term, which stretches out the loan for longer and ultimately increases the amount of money they pay in interest fees.
Homeowners who refinance to a lower rate, but keep their existing term (the number of years left to pay on their loan) save the most on interest in the long run.
Financial professionals also remind homeowners that the decision to refinance a mortgage should never be driven by interest rate activity alone.
It only make sense to refinance, for example, if you intend to remain in your house for long enough to offset the closing costs involved, which is referred to as the break-even point.
Other factors include the rate you are currently paying, the impact on your monthly payment, and whether your credit score has changed since you originally took out your loan. Only those with the highest credit score can secure the lowest mortgage rates. (Learn more: Improving your credit score pays off)
Home equity loans and lines of credit
Falling interest rates also favor homeowners who need to tap their home equity via home equity loans or lines of credit.
A home equity loan is a loan for a fixed amount of money at a fixed interest rate that is secured by the borrower’s home. Borrowers are typically limited to 85 percent of the equity in their home, but the amount of the loan also depends on their income, credit history, and home’s market value.
With a home equity loan, you can use the money you borrow for whatever you need, including home repairs and college tuition, and you repay it with equal monthly payments for a fixed term, much like your original mortgage. If you fail to make your payments on time, however, your lender could potentially foreclose on your home.
When rates are low, it costs less to borrow using a home equity loan. Because the interest rate is typically fixed, however, interest rate fluctuations have no impact on borrowers who already have a home equity loan set up.
A home equity line of credit (HELOC), which offers a variable interest rate, works differently. As the name suggests, a HELOC is a revolving line of credit, like a credit card, that uses your home as collateral against default. The amount you may borrow is based on a percentage of the equity available in your home. And you can spend the money on anything you may need up to the credit line by simply writing a check or using a credit card connected to the account, according to the Federal Trade Commission.
You only repay and owe interest on the amount you actually spend. Because that interest rate is variable, the monthly payments on a HELOC balance become more affordable when market interest rates fall. “Since the credit line is secured by a dwelling, the interest charged on what you borrow is generally far lower than what you would pay on an unsecured credit card,” according to Debt.org. “The catch, of course, is that the home secures the HELOC. If you default, the lender can foreclose on your home.”
Credit card balances
Most credit cards also charge borrowers a variable annual percentage rate (APR) that is pegged to the prime rate. When interest rates fall, the rate they charge customers who carry a balance falls too.
The average U.S. household with revolving credit card debt carries a balance of $6,849, which costs them an average of $1,162 per year in annual interest, according to NerdWallet.com.1
A drop to 17 percent from 18 percent helps, but only slightly. Joyner said consumers who pay only the minimum monthly payments on their credit card debt should take whatever extra savings the lower interest rate provides and apply that toward their monthly payment to rid themselves of high-interest debt faster. (Learn more: Managing debt in a balanced way)
Student loans
Most federal student loans have a fixed interest rate. Thus, those with an existing federal student loan with a fixed rate are not affected by interest rate moves.
But the interest rate charged on new student loans, whether fixed or variable, does generally fall when the Fed cuts rates.
If you have a private student loan with a variable rate, you may wish to explore through your current lender or a different one whether refinancing to a lower rate may make sense for you – or whether it might save you money to switch to a fixed rate and lock in savings. (Related: Student loan refinancing)
Savers
While falling interest rates can be a net positive for borrowers, it has a potentially negative effect on savers. They also use the prime rate to pay savers for deposits.
Indeed, rock bottom interest rates mean rock bottom earnings for money parked in savings accounts, money market accounts, and certificates of deposit (CDs) — a staple for emergency funds.
Savings accounts have been paying less than 1 percent for more than a decade, far less than the rate of inflation.2 That results in a loss of purchasing power.
Falling interest rates, of course, also mean reduced returns for potentially lower risk investments, such as bonds, which disproportionately affect retirees who seek to preserve wealth with minimal risk. (Learn more: The road to an interest-only retirement)
Market interest rates and bond prices generally move in opposite directions. When interest rates fall, the price of previously issued fixed-rate bonds that offered a higher rate typically rise.
Borrowers and savers may wish to connect with their financial professional to determine how the current interest rate environment may affect them.
Learn more from MassMutual…
Credit card debt: The problem, fixes and prevention
Seeking relief when student loans are unaffordable
Need financial advice? Contact us
This article was originally published August 2020. It has been updated.
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1 NerdWallet, “2023 American Household Credit Card Debt Study,” Jan. 8, 2024.
2 Federal Deposit Insurance Corporation, “Weekly National Rates and Rate Caps – Previous Rates,” July 15, 2024.