Episode Transcript
[00:00:00] The Fed recently lowered interest rates by half a percent. And in this episode, we give you a refresher on not just what that means, but more specifically what it means for your finances. Let's get started. Let's get some money from new money new problems. It's the new Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
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[00:00:42] I'm Brenton Harrison, and this is the New Money New Problems podcast.
[00:00:49] Hello. My name is Brenton Harrison of new Money new problems and your host for the new Money New Problems podcast. I hope that the weather is getting that perfect mix of cool in the morning and warm during the day, like it is in Nashville. It's my favorite time of year and in this episode. So we wanted to kind of get ahead of some things that you're going to hear about in the general economy, some things that you might have already heard about and talk about how it impacts you. You might have seen news that the Federal Reserve decided to lower interest rates by half a percent. So this is one of our what's in the news episodes, where we talk about these things that you're seeing online and then give you, like, a real world connection to what it means to your financial plan and how you can adjust in ways that most benefit you. So, as a recap, this is way back at the start of the podcast podcast a couple of years ago, we, uh, did an episode where we said, what does it even mean when the Fed raises interest rates? Because about two years ago, the Fed had raised interest rates to the highest level they had been in almost like 30 years. And we went through step by step what the rate is, to which theyre even referring, and talked about some things that you should do when interest rates were raised. So if this sounds kind of like the inverse of that episode, its because its the inverse, right? Rates are going down. So many of the things that we said to do, were going to do the opposite of that in this episode. So let's first go to what the rate even is. When you see news stories talking about the Fed lowering or raising rates, they're talking about the federal funds rate. And as odd as this sounds, the federal funds rate is the rate that banks charge to borrow money from each other. We've done other episodes where we've talked about fractional reserves and how it may seem like your bank keeps millions and billions of dollars on hand, but a lot of that is out in the streets and they have to keep a certain level of reserves. But at times when they need a little more liquidity, a little more money in the bank, they will actually borrow money from other banks, and they just don't get that money for free. Banks have to pay interest on money they borrow, just like you and I do. And the rate that they pay is called the federal funds rate. That rate is set by the Federal Reserve. And the interesting thing about this rate is it has impacts on almost all levels of the economy, either directly from loans or financing instruments that base their rate directly on the federal funds rate, or indirectly for other types of index rates or indices that are impacted when the federal funds rate is changed. An example of this is the prime rate, and the prime rate is the rate that banks charge basically their most credit worthy customers, right? So if banks pay a certain amount to borrow money from other banks, they want to then make a spread on what they charge their most credit worthy customers to lend money to them. So the prime rate is typically going to be a little higher than the federal funds rate. And there are many forms of financing, like home equity lines of credit, like car loans, like some credit cards that base their rate off of the prime rate plus a buffer. So they may say, if a HELOC is offering a new account to a customer, we are prime plus 2%. So that means that whatever the prime rate is, they're adding 2% onto that rate. And that's what they're charging the customer for the home equity line of credit. So if the federal funds rate is lower, the prime rate may be a little bit higher, but it's going to decrease with the federal funds rate. And you can then see a decrease in things like your home equity line of credit credit. There's also things like the secured overnight financing rate, which is the rate that you would pay on a loan that you have collateralized with treasuries. So we've also talked about the fact that you're going to pay more for like a credit card interest rate than you are with a car loan. That's because a car loan is secured by the car, right. If you don't pay your loan, the bank can just come get the car. And that's why they don't have as much risk and they don't charge you as m much as with a credit card where there's nothing to seize or repossess in the event that you're not repaid either, they just don't get their money. They can charge it off, but there's fewer recourses, which is why the rate is higher. So the federal funds rate impacts a whole lot of stuff in our economy. And when you hear that it has been lowered by half a percent, that is a huge increase, especially when you consider bigger ticket items like a mortgage, like a car loan, where that half a percent can make a monumental difference in the amount of money that you're paying on a monthly basis. So after the break, we're going to go through five different things that are impacted by this lower interest rates and what moves you can make to be on the right side of that impact.
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[00:06:30] All right, let's get started. The first area where we're going to start is something that you probably are looking forward to if you're in the market for a home or looking to sell your home. And that is mortgage rates. Mortgage rates have climbed from what was in the two and 3% range during COVID to up in the seven and 8% range over the last couple of years. But within two or three days of the announcement of lowering rates, I already saw that they were back down to their lowest rates in the past two years. So when you have this type of impact, it opens up a great number of opportunities, regardless of whether you are buying or selling. If you are selling, there's likely going to be, um, more people who are looking at your home because there's more people who have been in a position in the past two years where that higher rate just took them out of the market. But lower rates mean lower borrowing costs, so you could see some uptick in activity, whereas the end of the year is typically a slower time in the housing market, right? People don't want to move when it's right around Thanksgiving time or Christmas time. But this is something where you actually might see an outsized amount of activity in the holiday season because of lower interest rates for people who are trying to buy. Now, if you are a, uh, person who is in your home, doesn't plan to leave your home, but happen to buy in the high sixes, the sevens, and the eights, it opens up an opportunity to potentially refinance that loan at a lower interest rate. But you don't want to just do that willy nilly. This is my arbitrary rule of thumb. Um, but I am typically against refinances if you can't save at least half a percent on your current loan. The reason is, unless they have found some way to lower or eliminate your closing costs, it actually costs money to refinance a home, unlike student loans, which we'll talk about a little later in the episode. So you want to do it judiciously. You don't want to just be adding 1015, $20,000 onto your mortgage balance, because when most people refinance, instead of paying closing costs in cash at the table, they just add it on to their refinance loan balance. So you want to make sure some people say quarter of a percent, I say half a percent to make sure the juice is worth the squeeze. But you don't want to just say, oh, my, uh, rate dropped, you know, 10th of a percent. So I'm going to go and look into refinance. It needs to be something that makes a substantial financial difference. The one caveat to that is if you have an adjustable rate mortgage, that has been a more recent episode that we have recorded, an adjustable rate mortgage is fixed for an introductory period of time, say five or seven years. And then I would say the most typical arm loans are going to adjust their rate every single year after that fixed rate period. And there are plenty of people who in 2019 or 2020, purchased a five year arm and that fixed rate is due to expire and now would be an ideal opportunity to potentially refinance, even if you're refinancing early to get out of that adjustable rate mortgage and into a long term rate with a fixed rate loan. And this could be something where it doesn't have to necessarily be a half a percent decrease. It could be the same interest rate you're paying for your arm. It could be slightly higher, but it takes away that risk of you getting to the end of that fixed rate period and rates having increased. So I would say that if you are someone who is staring down the barrel or maybe you have a year or less left on that fixed rate period to consider that arm loan being refinanced while interest rates have decreased into a fixed rate long term home loan, to take that risk off the table. And if youre on the buying side, the obvious would be, hey, its going to cost you a little less to buy that home than it would have a few months ago. But I would also say that this opens up the opportunity to do whats called buying down your interest rate. Buying down your interest rate typically involves paying an extra percent or 2% in closing costs of the home loan amount. So if you have $100,000 home loan, they call it points instead of interest. One point on $100,000 loan would be $1,000, 1% of the loan. So a bank may say the interest rate on, um, this mortgage is 6%, but if you pay two more points at closing, then we'll lower it down to 5.5%. It's called buying down your rate. And we're now within that window of time where you might have a combination of excellent credit that, you know, qualifies you for a home that's in the high fives, and maybe you can buy down that rate so that you're in the low fives or the high fours, and that could be an opportunity to take advantage of those combination of factors, put you in a really good position. Number two are variable rate loans. We talked about home equity lines of credit before the break. But a variable rate loan, like a home equity line of credit, like some private student loans, these are things that can be really beneficial when rates are low, but they can also get away from you if rates increase over time. So you have people who took out money on home equity lines of credit when rates were low, and they have seen those rates skyrocket over the past two years. And the good thing is, with those, you only have to pay interest only payments, which can make them very flexible when it comes to your budget. The bad thing is you only have to make interest only payments. So if you are not biting into that principle, you could have a five or a ten year home equity line of credit, where at the end of that period, you're forced to come up with all of the principle, all of the corpus, because you haven't had the discipline or the ability to actually pay interest and principal over time. So if you've been paying on a HELOC already and the rates were really high. One tip or trick that I would offer to you is to keep your payment exactly the same. Even though interest rates on that line of credit will likely fall, it's not going to have any additional impact on your budget, but you will at least be making an incremental impact on the principal on a monthly basis. And if you can make bigger payments, I would encourage you to do so. Because if you can make that principal and interest payment when rates are as low as possible, it will make it as easy as possible to pay back the debt. And while we're on that topic, another opportunity that's opened up with lower interest rates, especially if you're in that category where either your rate is low or you can buy it down through the course of refinancing, is what what's called a cash out refinance. Typically, a cash out refinance would involve you looking at the equity in your home and cashing it out. So maybe you have a home that's worth 300,000. You only owe 100,000 on the home loan. So maybe when you do a refinance, instead of continuing to owe 100,000, you borrow $200,000, meaning you cash out $100,000 of equity, and at closing they give you a check for $100,000. It's called a cash out refinance. Maybe in this scenario, instead of taking cash out, you do a refinance that instead rolls what you owe on the line of credit into your new mortgage. So that instead of being stuck with likely a higher and variable interest rate on the HELOC, you have all of that on your fixed rate home loan and have a payment that will definitively pay off what you borrowed in a set period of time for a set amount. Number three is private student loans. We won't rehash this because we've talked about this ad nauseam on this podcast and our separate escape student loan debt podcast. But with a private student loan, when you refinance it, there are no closing costs or origination fees. So you have the ability to refinance these loans as frequently as benefits you. Which is why when I have people who already have private student loans, I encourage them to check rates as frequently as once a quarter. So if you already have a private student loan, especially if you have a variable rate loan, this may be a period where you either look in to see if you can find a lower rate or a comparable rate to what you're already paying that is fixed instead of variable. And this is something that I would encourage you to do more frequently over the next few months because you can see these types of things change quickly when the fed lowers rates. If you are a federal student loan lender, you're probably very frustrated with the things that are going on with IDR plans and the like right now. And if you're considering having your student loans forgiven, then this doesn't apply to you. But if you're on that line where you're trying to decide whether it makes the most financial sense to pay it off or have it forgiveness, then you could consider a private student loan refinance. And this would be another area where another benefit of looking into those private student loans is most lenders allow you to get an idea of what you would owe on that interest rate by doing a soft pull of your credit that does not impact your credit score. So as a result of this fed lowering of rates, this is an area where you could see some potential benefits as well. Next, credit card debt. No, we're not talking about the fact that it is technically true that this will likely lower interest rates on your credit cards. What I'm talking about is the strategy we've referenced in the past where you can use either a home equity line of credit or a personal loan to pay off credit card debt. And the benefit of doing that is twofold. The first is the rates are lower. That's obvious. But also these are forms of debt that do not impact your credit utilization. So you can take money from a home equity line of credit or a personal loan, use it to pay off your credit cards, and even though you still owe the same amount, your credit utilization has decreased as a result of the fact that you have moved it to installment debt instead of revolving debt. And as you see these interest rates decrease. It's a wonderful opportunity to not take advantage of the lower credit card rate, but take advantage of the lower personal loan rate to get rid of that credit card debt once and for all. Because as I've shared, it is the most insidious form of debt you can have, in my opinion. And then lastly, savings and cds. And this is more taking advantage of opportunities in terms of the interest rates that you receive. Receiving these have been like the glory days these past few years, which is kind of the silver lining in the sense that we have gotten sky high rates on high yield savings accounts, five and 6% when in the past you were getting one, one and a half percent on high yield savings. And you will likely see those rates decrease over time because banks are not going to offer you five and 6% when the federal funds rate has decreased to this extent. So if you're looking for a high yield savings, you might consider looking for an institution that will offer you that high rate for a minimum period of time, maybe a year, maybe two years, because you don't want to go through the process of moving all of your money over to a new bank just for them to decrease rates a month or two later. So if you're in the market for a new account, this is something you can look out for. If you already have a high yield savings account, you just need to be aware of the fact that these days are likely coming to an end, and that 5 may creep down to four or three or two. And we might need to have a different consideration for where we keep our cash. That's a little bit above emergency funds, but you don't yet want to put in the market. And when it comes to cds, we talked about this very recently. I'm not the biggest fan of cds, but if you are one of those people who just decided it's right for your portfolio, then I would consider locking in a rate with a CD, even though I'm just not really a fan of the accounts, because you will also see newer cds with lower rates in the next few months. But I would also warn you that if you're looking in the marketplace and you think that you found just the highest CD that's available, make sure that it is not what's called a callable CD, which is a CD that is technically a contract, but the instant institution offering the contract can rescind it at their discretion. And basically, that means that if rates decrease and that institution knows that they don't have to have a CD that's offered at five or 6%, they can simply call that contract in spite of your agreement that they would give you that interest rate for a fixed period of time, and they can just say, that's done, that's not the current rate, so we're not offering it anymore. So if you find a c that fits you, you want to make sure that it's not callable so that you don't get three or four months into the contract. And you thought you were getting one interest rate just to have that contract canceled. Those are just a few ways that the interest rates are impacting you. I hope this was beneficial. We have some really interesting episodes upcoming, uh, in the next few weeks and months, so hope that you're right back here next week to tune in. Talk to you soon from new money new problems. This was the new Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
