Whenever the Federal Reserve makes a move, it dominates headlines. I watched CNN for a while yesterday while waiting for a meeting and they kept going back to the big news that the Federal Reserve cut the prime lending rate by 0.75%. Most news stories make it clear that this is theoretically beneficial to stocks, and it did prevent a stock market collapse, turning a potentially terrible day on the stock market into just a mildly bad one.
However, for most people the actions of the Federal Reserve seem to have no connection to their day to day life. The prime lending rate? What does that have to do with my day to day life?
First of all, the prime lending rate is the interest rate that banks charge each other for short term loans. If a bank needs some quick cash, it can always borrow it from a bank down the road for that prime lending rate. Thus, most banks use this rate as the baseline for the interest rates they can give on savings accounts (they should be less than the prime rate, or at least close to it) and also on the interest rates they can give on loans (these should be above the prime rate, but competition keeps them low).
Thus, many, many other rates that do affect your life are affected by the prime lending rate. Let’s look at them.
The interest rates on your savings accounts will drop. Your local bank probably won’t change much – they offer so little on the average savings account that it doesn’t matter too much. However, over the next few weeks, a lot of online savings accounts will adjust downwards – probably something close to 0.75% in their savings rate. Some banks will change faster than others, so the next month is a bad time to do any rate jumping. Just stick with where you’re at, know that rates will go down, and wait it out for a bit.
The interest rates on mortgages will drop, perhaps convincing you to refinance. If you were looking at buying a house with a nice, stable thirty year fixed mortgage, this is amazing news because your mortgage rate will drop around 0.75%. On a $200,000 thirty year loan, Ben Bernanke just saved you $71 a month for the next thirty years – a total of $25,635.
That’s a lot of cash, and people out there with a fixed rate mortgage might be interested in refinancing if they can save $15,000 over the life of their loan. It might cost $3,000 or so to refinance, but if the total savings is $12,000 over the loan’s life, that’s plenty of incentive for most people. Incidentally, this will drive a lot of cash into the coffers of mortgage lenders, which will help with the subprime mess.
The interest rates on car loans will drop. This means that if you buy a car in the next few months, the payments will be substantially lower than they would have been without this drop. Since I’m personally thinking about purchasing a van in the early summer, this is good news for me.
The interest rates on variable rate credit cards will drop. Most credit cards have their rate fixed at the prime rate plus some specific percentage – prime plus 11.9%, for example. Since the prime rate just dropped by 0.75%, many credit card rates just dropped 0.75%, which will help a bit if you have a large credit card balance.
In a nutshell, when the Federal Reserve drops the prime lending rate, they’re encouraging you to spend money. Savings accounts become less of a bargain while, at the same time, loans become cheaper. This encourages people to go out and buy stuff.
In terms of stocks, when it looks like people are going to be buying more in the next few months, the stock market goes up, as that means a lot of companies that sell stuff are going to be getting more business.
In short, now is a good time to start thinking about larger purchases that you may need to execute soon. If your car is having troubles, you may want to start investigating good deals on cars, for example, or if you’re looking to buy a home, consider moving forward with that process. That doesn’t mean that you should go out and spend, but instead realize that it may be a frugal time to make a necessary big purchase.