Smart moves to make when the Fed starts cutting rates

New York (CNN) — Over the past couple of years, the Federal Reserve aggressively raised its key interest rate to a 23-year high to beat down inflation. Now that inflation has slowed substantially and is expected to cool further, the central bank is expected to embark on a rate-cutting campaign over the next two years, starting as early as September.

If it does, rates should decline on a wide swath of financial products for Americans, from credit cards and home loans to bank accounts and certificates of deposit, among others.

Given how many ways lower rates can affect your finances, here are some things to consider when deciding what steps to take in response.

Timing and magnitude matter

The prospect of lower borrowing costs will be welcome news to those seeking loans or anyone trying to reduce their existing debt loads. But, realistically, how much you’ll save when the Fed lowers rates will depend on how quickly it cuts and by how much each time. The answer for the near term is most likely to be “not that much.”

“Interest rates took the elevator going up, but they will take the stairs coming down,” said Greg McBride, chief financial analyst at Bankrate.

By that he means: “Rates are not going to fall fast enough to bail you out of a bad situation [this year],” McBride said. “And for savers, [the initial declines] won’t wipe out your interest earnings. Savers will still be way ahead of the game.”

That’s because one or even two quarter-point rate cuts this year won’t meaningfully reduce many of your interest costs. But several cuts over the next year or two could make a noticeable difference, and it may be worth holding your fire on some moves until then.

“Don’t jump the gun too early on this stuff,” said Chris Diodato, a fee-only certified financial planner and founder of WELLth Financial Planning.

Here’s a breakdown of how lower rates may affect key areas of your financial life, along with tips from Diodato and McBride on what to do about it.

Your home

Getting a mortgage is one of the biggest financial moves most people ever make. Mortgage rates are influenced by a number of economic factors, and the Fed’s moves are one. Since loan amounts are substantial, this is one area where even small cuts in interest rates could make a meaningful difference in what a homebuyer will pay.

For those buying a home this year, you may be tempted to buy down points to reduce your mortgage rate. Before doing so, Diodato advised, crunch some numbers to make sure it will actually save you money if you think you may be tempted to refinance in a year or two should rates drop further. That’s because you will pay thousands of dollars to buy down your mortgage rate now, and then thousands more in fees to refinance.

To buy down a quarter of a point might cost you 1% of your loan or 4% for a full point, he said. To refi, the costs could be higher — they typically run between 2% and 6% of your loan, according to Lending Tree.

Given that mortgage rates have fallen at least 1.25% in every rate-cutting cycle since 1971, and often over 2% or 3%, Diodato sees it this way: “Buying your rate down a quarter of a percentage point, or even a full percentage point, wouldn’t stop most people from wanting to refinance at some point during the next rate-cut cycle. So, my rationale is not to saddle folks with both paying for points and then the costs of a refinance.”

As for taking out a home equity line of credit, be aware that it’s no longer cheap money to borrow: The current average rate range for HELOCs is roughly 9% to 11%. A couple of quarter-point rate cuts from the Fed won’t make it meaningfully cheaper, McBride said. “Americans are sitting on more equity than ever, but you have to be judicious about how you tap into it, given how much it costs to borrow against it. Just because you have equity doesn’t make it free money.”

Of course, if you’re just taking out a HELOC to serve as an emergency lifeline and you never tap it, the rate may be less of a concern. But it still may cost you money by way of closing costs, any requirement that you withdraw a minimum amount at closing, or any other ancillary fees for having the line, such as an annual fee or inactivity fee, McBride noted.

And if you already owe money on a HELOC, he suggested, “aggressively pay it down. It’s high-cost debt that won’t get cheaper soon.”

Your credit cards

Another perpetually high-cost form of debt is your unpaid credit card balances. A few rate cuts won’t make much of a dent in today’s record-high average rate of 20.7%. Even if rate cuts ultimately push down the average to where it was at the start of 2022 — 16.3% — it will still be a pricey loan.

That’s why, if you’re carrying credit card debt, the advice is the same as it has always been: If you qualify, sign up for a zero-rate balance transfer card that can buy you at least 12 to 18 months interest free so you can meaningfully pay down the principal you owe.

If that proves difficult to get, see if you can transfer your balance to a credit card from a credit union or local bank that offers lower rates than the biggest banks. “They typically have fewer perks, but their rates can be half as high,” Dodiato said.

Your car

If you want to finance the purchase of a new car, a rate-cutting environment may not help as much as you think. McBride notes that every quarter point cut knocks $4 a month off a typical loan for a $35,000 car. So a full percentage point drop amounts to just $16 a month, or less than $200 a year.

“Your real lever for savings is the price of the car you choose, how much you’re financing and your credit rating,” he said.

As for leasing a car, McBride noted, the effect of a Fed rate cut may be equally small on the so-called “money factor” you will pay to lease, and because many variables determine what that factor will be, it will be hard to figure out the impact of lower interest rates.

Your savings

The past year has been very good for anyone who parked cash in online high-yield savings accounts, many of which have been paying north of 5%. The same goes for those who could lock up their cash for certain periods of time in certificates of deposits or Treasuries, many durations of which were also paying north of 5%.

While those rates will start to come down when the Fed starts cutting rates, the drops aren’t likely to be huge at first — meaning you will still be able to earn more on your savings than the rate of inflation for a while, McBride predicts.

But it may no longer make sense to leave quite as much cash in these types of vehicles going forward. “I caution people against the cash trap. A lot of people, used to these nice savings rates, were diverting money from stocks and longer-term bonds,” said Diodato, who predicts yields on savings will eventually fall to 3% in the next two years.

His advice: Don’t keep more than six months’ to a year’s worth of living expenses in cash or cash equivalents. “Anything more than that and you’re putting a drag on your future net worth,” he said.

That said, McBride suggested that if you’re within five years of retirement, you might want to lock in some high rates still on offer today to grow the cash you’ll want to cover living expenses in the first few years after you stop working. Having that cash on hand means you won’t be forced to pull from your longer-term portfolio should there be a big market downturn at the start of your retirement.

For instance, many CDs with durations of two, three, four or five years are currently paying between 4.85% and 5% on Schwab.com. If you do opt for such a longer-term CD, try to find one that is not “callable.” A callable CD is one that the issuer can decide to close out before its maturity date, which might happen if rates fall considerably during the next few years.

“The call feature is a ‘Heads I win, tails you lose’ for the issuing bank,” McBride said.

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