The Federal Reserve often responds to major economic events by raising or lowering interest rates. While these moves have a big impact on the economy as a whole, they have a different impact on consumers than they do on financial institutions. Learn more about how to interpret interest-focused news stories with this guide.
Financial News Headlines Don’t Tell the Whole Story
In March 2020, news outlets of all stripes announced that the Federal Reserve (or “Fed”) had cut interest rates to 0%. It was described as a move to help stimulate the economy after the sudden crash caused by the global COVID-19 crisis, and while rate cuts in response to economic downturns aren’t uncommon, that drastic of a cut is rare.
Reading the headlines alone, it would be easy to think that interest rates, generally, had been cut to 0%. In fact, our Mortgage Specialists received many inquiries about this from clients hoping to score a once-in-a-lifetime deal on their mortgage purchase or refinance.
Unfortunately, headlines saying that the Fed “slashed interest rates to 0%” don’t tell the whole story. When news outlets report on the Federal Reserve cutting interest rates, they’re actually referring to a single rate known as the federal funds target rate. The actual logistics behind this type of adjustment are complex; what’s important for consumers to know is that when the Fed cuts its interest rate, that doesn’t immediately translate to an equally low rate for things like credit cards or home loans.
This fact was seen in action in March 2020. Interest rates did drop that month, but they stayed well above 0%. You may be able to get a 0% introductory rate on a credit card, but that rate will likely last for a finite period, and those offers aren’t generally tied to the federal funds target rate.
As for mortgages, 0% interest is essentially unheard of. So don’t make any big decisions expecting to get 0% interest rates when you read headlines like that. The Fed’s rate cuts do have an impact on our lives as consumers, but those impacts are relatively indirect.
The Federal Reserve and Its Impact on the U.S. Economy
It isn’t necessarily important for you to understand, in great detail, all the nuts and bolts of the economy to be an informed consumer. You know how to drive a car, but you probably don’t know how every single part and mechanism in the vehicle works. Most drivers know enough to be able to describe basic problems, perform routine maintenance and operate their cars safely, but they aren’t mechanical experts. That’s a good metaphor for how you can approach the national economy and understanding your place in it. You don’t need to be an expert in all the technicalities, but you do need to know enough to interpret potentially beneficial news.
What’s important to understand about the Federal Reserve is that it is an extremely powerful organization with a huge influence on daily life in the USA. However, the Fed doesn’t create laws or set policies that govern things like what kind of return you get from a savings account or how much interest you’ll pay for your new car.
Instead, the Fed deals with banks and other major financial institutions, which are directly impacted by the federal funds target rate. Banks regularly lend each other money, and the federal funds target rate defines how much interest they pay for the money they borrow from each other.
This is how the Fed’s rates filter down to impact you, the consumer. If a bank has to pay more interest to borrow money, they’ll then charge consumers more interest to make up the difference and secure profit. The higher the interest, the more expensive it is to take out a consumer loan, and the less likely people are to borrow money and make big purchases.
When the Fed needs to stimulate the economy, it lowers its target interest rate so banks can offer loans at lower interest, which makes them more appealing for consumers. That, in turn, will ideally lead to more big purchases, which would have a strong positive impact on the economy as a whole.
So, while the Fed’s rate cuts don’t necessarily translate directly to equal savings for consumers, they are designed specifically to allow for banks and other lenders to provide lower interest rates and entice people to do things like buy houses.
What This Means for Current and Future Mortgage Borrowers
Ultimately, the impact of these interest rate cuts play out differently on a case-by-case basis in the mortgage industry. Different mortgage lenders will set different rates, and borrowers don’t necessarily always qualify for the lowest-possible rate offered by their lender. For people planning to buy a new home or property, though, a cut to the federal funds target rate generally means they can expect to lock in a good rate at the outset, one that may stay favorable as the economy recovers and rates go back up.
For those who already own a home and hold a mortgage, the impact of these rate cuts also varies depending on their current loan terms and whether they can qualify for a refinance. If you hold a variable-rate mortgage, it will automatically adjust to reflect the lower rates. If you hold a fixed-rate mortgage, your rate will not change. To take advantage of the lower rates, you’d need to refinance.
Like all financial topics, interest rate cuts from the Fed can be hard to understand. We hope this simple guide will help you put news stories in perspective when you hear them, but if you have further questions, please don’t hesitate to reach out to us for an explanation. Your local Mortgage Specialist would be happy to answer your questions and help you understand whether now is a good time for you to buy or refinance.