The Fed has cut rates close to zero in response to COVID-19
With so many businesses and residents reeling from the trickle-down effects of travel bans, social distancing and more, the Federal Reserve this month made a historic move in cutting interest rates yet again in an effort to mitigate the economic burden on Americans.
But what exactly does a Federal interest rate of nearly 0% mean to you?
It doesn't mean mortgages are now interest free, but it will affect rates from savings to future student loans and even credit card debt.
To make things as easy to digest as possible, TD Bank spoke to several experts in the fields of Consumer Deposits, Products and Payments, Credit Cards and Unsecured Lending and more to break things down in the simplest terms.
Credit Card Debt
When it comes to credit card debt, most interest is variable and calculated by an annual percentage yield or APR. You are usually told this APR when you sign up. And when the Fed cuts rates, these variable rates also decline.
The most recent average available for balance-carrying American households is $9,333.
"With decreases over the last month reducing interest rates by 150 basis points, including the recent decrease to 0%, cardholders with this balance would see their monthly interest payment reduced by about $11.66 per month," said Mike Kinane, Head of U.S. Bankcards, TD Bank.
That might not seem like a lot, but for someone owing this balance, that's around $140 a year.
Usually the best ways to keep your money safe, while earning a little bit in interest are savings accounts.
And while the return is often very little compared to the stock market or other unsecured investments, the risk is also very little because it's safer. In the stock market, your money is not guaranteed, while a savings account is usually backed and insured by the federal government to a certain limit (The FDIC standard is $250,000 for all insured accounts at one bank).
So, when the Fed cuts rates, sadly the interest you make in a savings account also gets cut.
"In this uncertain environment, customers are increasingly turning to savings accounts to protect their funds. When the Fed cuts rates, it lowers the rates banks earn on their deposit portfolio as a whole, and in turn, banks will lower the rates we pay customers on savings accounts," said Lindsay Sacknoff, Head of Consumer Deposits, Products and Payments. "We are doing our best to provide our most competitive rates and will continue to track the actions of the Fed and make adjustments as needed.
There's a common misconception that a Fed rate cut will have a direct and immediate impact on mortgage rates – but that's not generally the case.
The Federal Funds rate is a short-term rate, while mortgage rates are longer-term and are more correlated to the 10- and 30-year treasury bonds. As a result, they don't move in lockstep with the Fed.
We saw examples of this in 2019, and early this year, we've seen this correlation further disrupted by the global economic situation and COVID-19.
However, U.S. treasury yields did fall to historically low levels in early March, bringing down mortgage rates with them. This has spurred the refinance boom that we're currently experiencing, with many homeowners inquiring about the long-term savings they may achieve by refinancing into a lower rate and, in some cases, a different mortgage product.
In the current volatile market, pricing for mortgages is shifting day-by-day and varies by lender. It's also important to understand that mortgage rates are specific to the borrower, including factors like credit score, debt-to-income ratio and more.
Student Debt and Student Loans
Most Federal student loans are on a fixed rate, so a lowering of the rate from the Fed may not affect recent graduates, who are currently paying off their loans.
It will, however, affect new students taking out loans in the coming year (2020-2021), as the fixed rate will be lower when they apply.
If you have a variable rate loan, then this Fed cut may affect you in a positive way that lowers the interest you currently pay. Variable rate loans for college students usually are from private organizations like Sallie Mae.