Consumers benefit from cut in US Federal rate
What happened?
In response to a projected weakening of the US economy, the US Federal Reserve cut interest rates by three quarters of a percentage point (75 basis points for you stock gurus) on the morning of Tuesday January 22nd, 2008. The cut gave a boost to the stock market which took a hit on Friday and Monday amid fears of a recession in the US, but what does it mean for you?
How does the Fed rate affect your interest rate?
The US Federal funds rate is the short term rate at which banks lend each other money and it, in a large part, determines all the other interest rates. A bank's prime rate is usually the Fed rate plus 3%. All other bank rates are set from the prime rate. So when the Fed rate falls, so does the rate you borrow at. What does that mean? Two things, borrowing just got cheaper and your current debt is now more manageable.
Borrowing is cheaper
You'll notice the effect the most if you have a good credit rating and want to make an expensive purchase such as a house, a car, or home furnishings. Borrowing money via home loans, car loans, and credit cards just got cheaper.
After the announced rate cut many banks cut their prime rate by 0.75%. Let's say you were thinking of remodeling your kitchen, if you planned to spend $20,000 you'd save $150. Not a lot but it adds up over the entire economy as more people decide to renovate their homes, lease a new car, or renew their mortgage.
Save money on the debt you already owe
Another benefit is that debts you already have are now more manageable. Mortgage holders who are due for the readjustment of their adjustable rate mortgage are in for a break on interest rates.
If this is so great why not reduce the rate even more?
The Fed lowers interest rates by increasing the amount of money circulating in the economy. If the interest rate falls too low then there's too much money chasing too few goods and prices rise. This hits retirees on a fixed income the hardest. It also hurts people by reducing the value of their savings. Long periods of inflation have a destabilising effect on the economy and lead to many problems.
