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Many borrowers believe that when the Federal Reserve (Fed) cuts interest rates, they’ll see immediate relief in borrowing costs associated with financial products like personal loans, credit cards, installment loans, or mortgages. However, the reality is a bit more complicated.
The Fed cut rates three times in 2024, and many economists anticipate that it may cut its interest rate again in September of this year after likely holding rates steady at its upcoming meeting later this month. These rate cuts do translate into lower borrowing costs for consumers, but it takes time for these cuts to impact most consumer borrowing rates, though.
Other factors, such as inflation, employment rates, federal borrowing, and geopolitics, also influence interest rates on longer-term loans like mortgages.
Key Takeaways
- Lenders use the prime rate, derived from the Federal Reserve’s federal funds rate, as a benchmark for interest charged on personal loans, credit cards, and other types of revolving debt.
- The Federal Reserve will change its interest rate to influence the economy, but it does not have direct control over consumers’ cost of borrowing.
- It takes time for the Fed’s rate cuts to impact the cost of borrowing, and other factors influence interest rates on longer-term rates like mortgages.
- Borrowers can proactively look for ways to manage and pay down their debt regardless of the outcome of the Fed’s rate cuts.
Rate Reductions Take Time—and They’re Often Limited
The Fed typically cuts rates by less than 1%. In September 2024, it cut its interest rate by 50 basis points (0.05%). In November and December 2024, it cut the federal funds rate by 25 basis points (0.25%).
Fast Fact
While these small cuts might reduce borrowing rates, they do not offset the Fed’s 11 rate increases made since the beginning of 2022.
When the Fed reduces or increases its rate, the impact on borrowers is not immediate. Some studies indicate it can ultimately take one to two years for a rate change to affect consumers.
For some types of borrowing, change may come sooner. For example, credit card companies may lower variable annual percentage rates (APRs) within a month or two of a Fed interest rate change.
High Long-Term Yields Undermine the Cuts
In the past year, consumers have not seen consistent or timely relief in the form of lower rates for mortgages, car loans, and credit cards.
Longer-term interest rates do not always decrease when the Fed cuts short-term rates. Following the Fed’s cuts last year, 10-year bond yields increased, hitting a high of 4.8% in January, according to Open Markets. Mortgages are closely linked to the 10-year U.S. Treasury yield.
The rates on auto loans have dipped, but car prices remain high and are likely to increase in the face of recent tariff policies. Consumers are having to borrow more to buy vehicles.
Credit cards with variable APRs followed along with the Fed’s rate hikes, beginning in 2022, but interest rates did not fully track with the Fed’s cuts in 2024. Instead, average interest rates only reflected about 60 of the 100 basis points of the cut in the Fed discount rate, according to the Federal Reserve Bank of St. Louis. This is likely because credit card companies are attempting to mitigate their risk in an uncertain economy. You typically won’t be notified in advance of a decline in your credit card rate, but it will be reflected on your statement when it takes effect.
Even if APRs do respond to an upcoming Fed rate cut, a fraction of a percentage reduction is unlikely to have a noticeable impact on consumer borrowing costs.
Fast Fact
Only variable APR cards respond to Fed rate changes. Fixed-rate cards are unaffected unless the issuer chooses to act.
When Cuts Finally Matter, It’s Often Too Late
The Fed typically changes its rate in response to economic conditions. When it seeks to encourage borrowing during a cooler economy, it cuts rates. If it wants to cool inflation, it raises rates.
If and when the Fed decides to cut rates again, consumers will already be experiencing the impact of an economic slowdown, and it will take time for that policy change to result in potentially lower market interest rates. For some consumers, changes in loan rates may come too late to help them, and they may need to pursue more immediate debt relief in the form of debt consolidation.
Bottom Line
If you’re carrying significant amounts of consumer debt, it’s not advisable to rely on any fed rate cuts to take immediate effect. Instead of counting on decreased borrowing costs to help your budget, focus on paying down your existing debt. Clearing debt can help you reduce your expenses and improve your credit score. You can also explore refinancing your debt to secure more favorable terms.
However you approach debt, it is important to create a budget that considers your income, spending, and long-term financial goals.
