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What Does the it Mean for You When the Government Cuts Interest Rates?


Any time the Federal Reserve cuts interest rates, consumers prick up their ears.

Unfortunately, unless you took a class in economics in college, you probably are aware that this interest rate cut affects loans tied to the prime rate, but after that only have a general idea of what it means specifically for you.

With that in mind, we'll take a look at same real effects that the Federal Reserve interest rate cuts in late 2007 as well as early 2008 have for the average American consumer.

The interest rate cut lowers monthly interest payments on variable-rate mortgages tied to the prime rate.

When the Federal Reserve cuts interest rates, they're not technically cutting the so-called "prime rate," the standard rate at which banks loan consumers money; they're cutting the "federal funds rate," which is the rate at which banks loan money to other banks.

However, cutting the federal funds rate does affect the prime rate, since the prime rate generally follows the federal funds basis rate, with a consistent difference of around three percentage points.

If you have a variable-rate mortgage, your interest rate will likely decrease.

This may give you the opportunity to refinance to lock in a lower rate to protect against rising interest rates raising your monthly mortgage payment. It's also good news if you have a home equity line of credit, since your debt is cheaper when rates go down.

However, if you have a long-term fixed-rate mortgage, you will not see a direct effect in your mortgage payments. Fixed-rate mortgages follow long-term bond yields rather than the short-term rates affected by the federal funds rate.

In any case, just a change in interest rates may not be enough to stop many homes from entering into foreclosure. It may be enough to relieve some individuals who are just a bit behind on their mortgage payments, but when facing foreclosure, many individuals owe more than they own on their houses, and any relief will likely be too little too late.

The interest rate cut lowers monthly interest payments on variable-rate credit cards.

Like variable-rate mortgages, the interest rate on variable-rate credit cards moves with the federal funds rate. Of course, unless you have a substantial amount of credit debt, you won't see drastic savings (and that may be a good thing).

Compared to mortgage interest rates, in which a few percentage points can mean thousands of dollars in interest savings, the smaller amounts of credit card debt may mean only as little as a few dollars in savings per month.

However, if you have a fixed-rate credit card, you may still be able to take advantage of the rate cuts.

Transferring your balance to a variable-rate credit card could pay off enough to offset any transfer fees. Just make sure you choose your credit card wisely, and be sure to make sure you read the terms of your agreement carefully, since variable-rate credit cards may change interest rates over the course of time, making any transfer a possible risk.

The interest rate cut lowers auto loan rates.

The short-term loan interest rates affected by the federal funds include auto loan rates. Lenders associated with car dealerships in fact typically offer low interest rates to entice would-be buyers into splurging for a new car or truck, and will use the opportunity to advertise even lower rates.

If you've been waiting to buy a new car or truck because of high interest, now is an opportune time to buy, provided that you can afford to make the payments on a car loan.

The interest rate cut lowers savings rates.

Though generally positive for consumers, rate cuts affect the interest rates paid on high-yield savings accounts.

This means if you've been using a high-yield savings account as a conservative investment opportunity, you'll see your returns diminish.

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