Mortgages, home equity lines of credit, auto loans, credit card rates, certificates of deposit, and money market accounts can all be influenced by changes in short-term interest rates set by the Federal Reserve. But don't count on getting a lower interest rate; first, read the fine print in whatever contract you're signing. The only interest rate that will automatically drop is the federal funds rate, which is what banks charge each other on overnight loans. Here are some ways to make the most of the rate cut announced by the Fed Tuesday:
Watch the market for lower rates. The Fed's rate cut should provide a measure of relief to borrowers anticipating rising payments on their adjustable-rate mortgages. "Borrowers facing resets will still see a sizable payment increase compared to the initial payment when the loan was initiated several years ago, but that increase will be substantially lower than it would have been had the Fed not changed interest rates," says Greg McBride, a senior financial analyst with Bankrate.com. The savings won't be huge, though. "If your adjustable-rate mortgage is due for a reset in October, you're going to see some benefit right off the top, so instead of jumping to 7 percent, it's going to jump to 6¾ percent." But many adjustable-rate mortgages are not tied directly to the prime rate, which is affected by the Fed's federal funds rate. "A reduction in the prime rate may not affect their payment at all or may not affect it for some time," warns David Jones, president of the nonprofit Association of Independent Consumer Credit Counseling Agencies.
Switch to a fixed rate. It might be a good time to consider converting to a fixed-rate mortgage. "Switching to a fixed rate would be a great idea, particularly if you can refinance and your adjustable-rate mortgage is still adjusting higher," says Mark Zandi, chief economist at Moody's Economy.com. Thirty-year fixed-rate mortgages dropped to 6.25 percent this week, down from 6.42 percent last week in anticipation of the Fed rate cut, according to the Mortgage Bankers Association. "You may want to wait a little longer because you'll probably get an even better deal sometime between now and the end of the year," says Zandi. But be sure to carefully weigh the effect of closing costs and fees before refinancing. And try to avoid late payments before you make changes, as even a single late payment can make it much more difficult to refinance and lock in a lower rate.
Tap home equity. "You will see lower home equity lines of credit because they're tied to the prime rate, so they'll come down one for one," says Zandi. If you can tap into your home equity to pay off higher-interest credit card debt, there are savings to be had. But watch rates closely before you sign up for a HELOC. "If you have a home equity line of credit, your rate will adjust lower following a Fed rate cut, but it often comes with a lag of one to three months," cautions McBride.
Switch credit cards. "Consumers should shop around and look for credit cards where the rate is tied to short-term interest rates and see if they can take advantage of that," says Gus Faucher, director of macroeconomics for Moody's Economy.com. Although credit card rates are heavily influenced by your own credit history, now is a great time to shop around for the lowest-rate card and aggressively pay down debt. "If it's a variable-rate credit card, chances are pretty good your rate will come down. With a fixed-rate credit card, it probably won't," says McBride. "If you consolidate onto a variable-rate card, you can do that now because as variable rates decline you will get that value."
Keep saving. Although borrowers may be getting a slightly better deal in the coming months, savers who sock money away in money market accounts and bank-issued certificates of deposit may see their interest rates decline. "Banks are going to be quick to lower their deposit rates, in part because they don't need the deposits because they are not making as many loans," says Zandi. With interest rates now topping 5 percent at many financial institutions, stashing your cash in a CD is one way to lock in high interest rates before they drop. "If you've been looking for an opportunity to put money into a long-term CD, now is the time to do it before rates decline," says McBride. But even if rates drop, risk-averse investors may still want to stick with these safe savings vehicles. "If interest rates fell 1 full percentage point, you're still looking at money market accounts or CDs at 4 percent and 4¼ percent," says McBride. If you have $10,000 to invest, the latter rate will yield you $425 interest earned per year.