It's the end of the year, so no one wants to hear about interest rates, right?
In fact, the holidays are when many of us think about money, specifically spending and borrowing.
That's why it's important to know that the Federal Reserve is set to cut interest rates by 0.25% at the conclusion of tomorrow's policy meeting. The Fed's rate decisions affect your credit card debt and whether you can afford to take out a car loan or a mortgage. Interest rates even influence how much annual percentage yield you earn from your savings account.
While one single interest rate cut won't directly impact your finances (nor immediately shake up the economy), the government's monetary policy and overall economic outlook will have an effect on your money over the long term.
Here's a quick primer on interest rates and what you need to know about tomorrow's Fed decision.
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How does the Fed set interest rates?
Interest is the cost you pay to borrow money, whether that's through a loan or credit card. Lower interest rates mean the percentage you owe on your outstanding debt is smaller. Lower interest rates can also reduce the amount a financial institution or bank pays you, i.e., what you earn, for investing your money, like with a savings account.
The Fed meets eight times a year to assess the economy's health and set monetary policy, primarily through changes to the federal funds rate, the benchmark interest rate used by US banks to lend or borrow money to each other overnight.
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Although the Fed doesn't directly set the percentage we owe on our credit cards and mortgages, its policies have a ripple effect on the everyday consumer.
Imagine a situation where the financial institutions and banks make up an orchestra, and the Fed is the conductor, directing the markets and controlling the money supply.
When the central bank "maestro" increases the federal funds rate, many banks tend to increase their interest rates. This can make the debt we're carrying more expensive (e.g., a 22% credit card APR vs. a 17% APR), but it can also lead to higher savings yields (e.g., a 5% APY vs. a 2% APY).
When the Fed lowers rates, as it has already done twice this year, banks tend to drop their interest rates, too. Our debt gets slightly less cumbersome (though not by much), and we won't get as high of a yield on our savings.
What do inflation and the job market have to do with it?
Financial experts and market watchers spend a lot of time predicting whether the Fed will hike or cut interest rates based on the direction of the economy, with a special focus on inflation and the labor market.
When inflation is high and the economy is in overdrive, the Fed tries to pump the brakes by discouraging borrowing. It does this by setting higher interest rates and decreasing the money supply. Since March 2022, the Fed raised the federal funds rate 11 times, which helped slow down record-high price growth.
However, the Fed takes a risk if it brings inflation down too much. Any major, rapid decline in economic activity can cause a major spike in joblessness, leading to a recession. You might hear the phrase "soft landing," which refers to the balancing act of keeping inflation in check and unemployment low.
The economy can't be too hot or too cold. Like the porridge for Goldilocks, it has to be just right.
How will a 0.25% interest rate cut affect your wallet?
Here's what today's rate cut could mean for credit card APRs, mortgage rates and savings rates.
🏦 Credit card APRs
Lowering the federal funds rate can cause credit card issuers to decrease the price of credit for cardholders, meaning you would be charged less interest on your outstanding balance each month. You won't feel the effects right away, and every issuer has different rules about changing annual percentage rates. However, you might notice your APR adjust within one to two billing cycles.
"Credit card APRs have remained high, even after multiple rate cuts this year. For those trying to pay down credit card debt, don't wait to see if the Fed will make more cuts in 2025. The interest will only keep piling on during that time. Your smartest move is to pay off your credit card balance every month or as quickly as you reasonably can." -- Tiffany Connors, CNET Money editor
🏦 Mortgage rates
The Fed's decisions impact overall borrowing costs and financial conditions, which influence the housing market and home loan rates, even though it's not a 1-to-1 relationship. For example, since the Fed started its series of rate hikes in March 2022, mortgage rates soared, reaching a peak last fall. Though home loan rates move up and down every day and are influenced by multiple factors, they remain high, keeping homebuyers out of the market.
"The Fed doesn't directly set mortgage rates, so another 0.25% cut this month won't immediately result in lower mortgage rates. That said, ongoing rate cuts through next year, combined with weaker economic data, still point to a long-term downward trend for mortgage rates. It just won't happen as quickly as anyone would like." -- Katherine Watt, CNET Money housing reporter
🏦 Savings rates
Savings rates are variable and move in lockstep with the federal funds rate, so your APY will likely go down following more rate cuts. When the Fed started raising rates, many banks increased their APYs for traditional and high-yield savings accounts, giving account holders bigger returns on their deposits. Just remember that not all banks are created equal, and we regularly track the best high-yield savings accounts and certificates of deposits at CNET.
"CD and savings APYs have fallen since the Fed cut rates in September and November, and another cut in December would mean they're likely to fall further. If you have some extra cash, stashing it in a CD or high-yield savings account now allows you to maximize your earnings before rates fall further." -- Kelly Ernst, CNET Money editor
What's next for the Fed's interest rate cuts?
Experts anticipate some rate cuts next year, though projections are changing given the potential impact of the new administration's economic policies. While market watchers and economists usually have varying opinions about the Fed's monetary policy, the pace of interest rate reductions is likely to slow in 2025.
Keep following CNET for Fed Day coverage. The decisions you make with your money are personal, but we're here to help guide you.
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