Interest rates are never static. The US Federal Reserve sets a target for the federal funds rate; ie, the interest rate that some institutions pay or charge each other for overnight loans. With the goal of attaining stable inflation and maximum employment, the Fed decides whether to lower or raise this benchmark interest rate.

A move by the Federal Reserve to push the benchmark interest lower is welcomed by borrowers who enjoy a lower cost of credit as a result. For others, though, there’s nothing smile about.

As an individual borrower, you don’t receive the Fed rate on loans, and you don’t need to grasp the inner workings of federal monetary policy. But a rate cut by the Fed is important because it influences the interest rates charged for auto loans, mortgages, credit cards, savings, and other forms of lending and borrowing.

The Fed cuts the federal funds rate in order to stimulate the economy; as a result of the rate cut, borrowing becomes cheaper and keeping money in savings accounts becomes less appealing. The Fed’s actions may affect your finances in several ways.

Why Does the Fed Cut Interest Rates?

When the Federal Reserve wants to stimulate the economy, it lowers the borrowing rate for short-term funds. In consequence, banks lower the interest rates imposed on consumers for various loans. All other things being equal, the lower rates result in more borrowing and spending, since consumers can now more easily secure financing for large purchases like cars and homes. Lower rates also encourage businesses to borrow money in order to build and expand their enterprises.

If and when it becomes cheaper to borrow money, money being saved in a bank earns less interest than it would when the Fed rate is higher. This may cause prices to rise; when money is worth less, you need more of it to satisfy your needs and wants. A little inflation may encourage people to buy more before prices soar. But unless inflation remains low, things can easily get out of hand.

Why Do Rate Cuts by the Fed Matter?

A rate cut by the Fed means lower rates for a host of credit products.

Mortgages

Fed rate cuts can have both good and bad effects if you want to buy a home or are making payments on a mortgage. Immediately after a rate cut, the rush to apply for mortgage loans by aspiring home owners or by home owners who want to refinance can create a backlog of applications and motivate lenders to increase lending rates. As demand eases, mortgage rates may fall and become aligned with the Fed’s rates.

Homeowners who are making payments on a variable-rate mortgage, like a home equity line of credit or an adjustable-rate mortgage, may see lower interest rates and therefore lower monthly payments. But keep in mind that since interest rates fluctuate, these rates may well increase later on.

If you’re making payments on a variable-rate mortgage, consider how many payments remain until you can pay off the loan and, if you plan to move, when you expect to do so. In a lower-rate environment, it may make sense to refinance with a home equity loan or a fixed-rate mortgage. If you won’t be moving anytime soon, a fixed-rate mortgage can help you benefit from the prevailing interest rates and gain stability and peace of mind. But be sure to take into account the closing costs you will have to pay as well.

Credit Cards

Most credit cards have a variable interest rate that closely follows a benchmark rate known as the prime rate. This rate is affected by Fed rates too. As the prime rate falls or rises, credit card interest rates on cash advances, balance transfers, and purchases follow suit. Cardholders may see a reduction in their annual percentage rate (APR) within a billing cycle or two.

Although fed rate cuts result in lower credit card rates, this may not make much difference in the short term if you are carrying a balance. In this case, consider negotiating a lower rate with the issuer of your credit card.

Auto Loans

Because car loans are relatively short-term loans—typically from two years to five years—these loans also benefit from the Fed’s rate cuts. The interest rates of car loans are based most directly on movements within the bond market, declining as the general cost of borrowing money declines. As in the case of other loans, the interest rates on auto loan are also substantially influenced by a borrower’s credit history.

Student Loans

The extent to which student loans are affected by a drop in interest rates depends on what kind of loan it is. Because Congress periodically sets the rates on federal student loans, these loans don’t react immediately to market movements.

Student loans provided by private lenders have either fixed or variable rates. If they are variable and the Fed cuts rates, the interest rate on the loan is likely to drop. How much the rate drops depends on what index the loan is tied to.

How to Protect Your Savings when the Fed Cuts Interest Rates

Although the fact that the Fed’s rate cuts make borrowing less expensive is good news for consumers seeking credit facilities, it isn’t good news for your savings. Banks will reduce the interest earned on savings and deposit accounts so that you earn less on the money you have deposited in these accounts.

Fortunately, there are a few strategies you can adopt and a few relatively safe havens where you can put your money to mitigate the impact of rate cuts.

Find a Competitive Rate

Since your savings account will feel the heat of the Fed’s rate cuts, make sure you are getting a competitive rate. Online-only banks provide high-yield savings accounts that offer more competitive interest rates than those of traditional brick-and-mortar banks. You may be able to find a high-yield savings account that offers an interest rate more than five times the national average.

Even in a low-rate environment, then, you may earn a higher return on your savings if you shop around for a more lucrative savings account. When comparing accounts, remember that the account rate is just the tip of the iceberg. Also check account fees. Excessive fees will eat into the interest you earn.

Consider CD Laddering

If you expect rate cuts to affect your savings account, look into certificates of deposit (CDs). Fixed-rate CDs have a set term that ranges from three months to ten years; during this term, the interest rate is locked. No matter how the market moves, the money in a fixed-rate CD continues to grow at the rate you locked in when you opened the account. So you enjoy higher-than-average yields if banks cut their CD rates before the term of your CD expires.

To further protect your savings, employ the CD laddering strategy. This strategy entails owning several Certificates of Deposit that have different maturity intervals; e.g., two years, three years, and five years. As the term for each CD lapses, funds become available that you can spend or reinvest. This method gives you more regular access to your money than investing the whole amount in a single CD while also continuing to protect a good part of your money from declines in the interest rate.

Switch to Stocks and Bonds

An environment of lower interest rates is a good reason to consider investing at least some of the money in stocks and bonds that you would otherwise invest in a CD or a regular savings account. Cuts in the federal fund rate may cause bond prices to increase intermittently, resulting in lower bond yields. Nevertheless, bonds may still deliver yields that are higher than what other investment vehicles deliver.

Short-term interest rates cut by the Fed may trigger better stock-market performance. If you can accept more risk, this may be the best time to add money to your investment accounts.

Pay Off Debt

You can reduce the impact of the Fed’s rate cuts on your savings by paying off some of your debt. Since you’re not earning much from the money in your savings account, why not clear some of your high-interest debt? Doing so will help you save more money in the long run.

Refinance Loans

An environment of low interest rates is also the best time to refinance loans to lock in rates that are lower than previously available.

Conclusion

The monetary policies of the Federal Reserve affect our lives, and we need to deal with the consequences of those policies. The Fed’s rate cuts enable you to access credit at a lower cost, but they also reduce what you can earn from a savings account. Finding rates that are more competitive, laddering your CDs, paying off debt, and moving cash to stocks or bonds are some of the strategies you can use to help protect your savings.