What Do Fed Rate Cuts Mean? Will My Loan Get Cheaper?

If you follow the news, you may hear discussion of the Federal Reserve, and whether it will lower interest rates. If you aren’t sure exactly how that works, you're not alone.

Let’s look at what the Federal Reserve does, how it makes interest rate decisions, and how those decisions could impact your current or future loans.

What Is the Federal Reserve?

The Federal Reserve, often called the Fed, is the central bank of the United States. The Fed's primary job is to keep the economy stable and create conditions that lead to steady employment. Part of its job relates to keeping inflation under control, which is where interest rate hikes and cuts come into play.

What Is the Federal Funds Rate, and Why Does It Go Up and Down?

The federal funds rate, also known as the Fed's benchmark interest rate, is the Fed's main tool for maintaining economic stability. The federal funds rate is the rate banks charge each other for overnight loans. It's tied to the prime rate, which influences what rates banks charge customers for loans. 

Since the Fed's job is to maintain a stable economy, it can raise or lower the federal funds rate as needed to achieve that goal. 

When the economy is growing too quickly and inflation increases, driving costs upward, the Fed can raise its federal funds rate. That tends to make borrowing more expensive, which can slow spending and help bring prices down.

When the economy is sluggish, the Fed can lower its federal funds rate. That tends to make borrowing less expensive, which can promote spending and help lead to more jobs and general economic growth.

How Fed Rate Cuts Impact Consumer Loans

The Fed doesn’t directly set interest rates on loans such as personal loans, auto loans, and home equity loans. Rather, when the Fed lowers the federal funds rate, it becomes cheaper for banks to borrow money overnight. Banks tend to pass some of that savings along to their customers in the form of lower interest rates on loans. 

If the Fed cuts rates when you're looking to sign a new loan, you may get a lower interest rate on it. Keep in mind, though, that loan rates don't always drop immediately following a Fed rate cut—it could take weeks or months for the Fed's rate cuts to lead to lower borrowing rates on consumer loans.

Note that if the Fed cuts rates, it generally doesn’t impact existing fixed-rate loans. When you sign a fixed-rate loan, you lock in the interest rate and monthly payments for the life of that loan. So even if the Fed lowers rates substantially, your payments don't change. However, in that situation, you may be able to refinance an existing loan into a new one with a lower interest rate.

While Fed rate cuts could lead to lower borrowing rates for loans such as personal loans, auto loans, and home equity loans, they don't tend to have as much influence on mortgage loans. Because mortgages are often repaid over a much longer time, they tend to be more influenced by long-term interest rates, and not the federal funds rate.

How to Get a Lower Interest Rate on a Loan

If you're applying for a loan, waiting for the Fed to cut rates so you can save money on interest may not help, because, as mentioned earlier, Fed rate cuts don't always immediately impact loan rates. 

It's also common for the Fed to lower interest rates slowly. A minor Fed rate cut may not bring consumer loan rates down all that much. 

If you hope to get a lower interest rate on a loan, here are some steps to take.

Boost your credit score

The higher your credit score, the less risk a lender tends to expect when it loans you money. If you can boost your score, you may be rewarded in the form of a lower interest rate on your next loan. You could boost your credit score by paying debts on time and reducing balances on your credit cards, but these steps may take time.

Shop around and compare offers

When you need a loan, shop around so you can compare the offers you receive. If one lender will give you a lower interest rate on a loan than another, it could lead to big savings.

Reduce your lender's perceived risk

The less risk a lender envisions when loaning you money, the better the interest rate you might get. You can reduce your lender's estimation of risk by agreeing to a shorter repayment period on your loan, or by lowering the amount you borrow. In some cases, such as with a car, that could mean making a larger down payment.

The Bottom Line

When the Fed cuts interest rates, it can make loans less expensive. However, if you have a fixed-rate loan in place, your payments won't change regardless of what the Fed does.

If you're having trouble making loan payments and are feeling overwhelmed by them, consider reaching out to a debt relief company to see what options you have. A debt expert could help you create a plan to get rid of your debt and get on with your life.