If you’re retired or soon-to-be retired, how could the recent cut in interest rates by the Federal Reserve affect your finances? Unfortunately, there’s not a simple answer, because it depends on your financial circumstances, investments, and sources of retirement income. And if you’re like many retirees, there could be both positive and negative effects on your finances.
Let’s see how your finances might be affected by the recent interest rate cut.
What Was The Recent Interest Rate Cut By The Fed?
On September 18, the Federal Reserve cut its target federal funds rate to a range of 4.75% to 5%, a reduction of 0.5%. The federal funds rate reflects the interest rate that banks charge other banks to borrow money. A lower rate helps consumer banks charge lower interest rates on consumer loans, such as mortgages and credit cards. The theory is that consumers will pay less to borrow money, which could stimulate their spending and the economy.
It’s important to note that it might take some time for the Fed rate cut to work its way to interest rates charged to consumers. A few financial institutions quickly reduced mortgage interest rates and credit card rates in response to the recent rate cut, but the impact hasn’t fully worked its way through the financial system. And keep in mind that some rates, such as the interest charged on credit cards, often exceeds 20% per year, which is far higher than the federal funds rate.
In its announcement, the Fed hinted at the possibility of future rate cuts to further stimulate the economy.
How Lower Interest Rates Can Help Retirees’ Finances
It’s important to note that the Federal Reserve generally reduces interest rates to stimulate and improve the nation’s economy. As a result, if you have a direct stake in the economy, sooner or later you should realize a positive gain from the interest rate reduction.
Here are situations when lower interest rates could improve your finances:
- Stock and bond investments often appreciate when interest rates drop. However, by the time you’re reading this post, your stock and bond investments have most likely already appreciated due to the recent interest rate cut. In other words, the cut has already been priced into the current market value of your investments.
- If you want to buy a home with a first mortgage, or if you currently have a variable interest rate mortgage, lower interest rates will reduce your monthly mortgage payment.
- If you have a first mortgage with a fixed interest rate, you might be able to refinance your loan at a lower rate, reducing your monthly mortgage payment in the process.
- If you take out a reverse mortgage on your current home, lower interest rates will reduce your borrowing costs and your accumulated loan balance will grow at a slower rate. This will give you more net home equity when you eventually sell your home and pay off the mortgage.
- If you have substantial credit card debt or any other form of consumer debt, lower interest rates could reduce the amount of interest you pay, thus putting more money in your pockets to spend. However, the rates charged on credit cards and other consumer debt often stay at high levels even when the Fed reduces the federal funds rate.
Lastly, we all have a stake in the national debt, since interest on the federal debt is one of the fastest-growing segments of the federal government’s annual budget. Lower interest rates could slow the growth of interest we pay on the national debt.
How Lower Interest Rates Can Hurt Retirees’ Finances
If you rely significantly on interest income from CDs, passbook savings accounts, and money market funds, you’ll most likely see a drop in your interest income. Also, once bond investments price in the impact of the reduction in interest rates, your bond investments will yield lower amounts going forward.
Another potential negative impact comes into play if you decide to buy a traditional income annuity, which pays a fixed monthly amount for the rest of your life. The prices of traditional annuities move in the opposite direction of interest rates, so the prices of these annuities will increase in the near future.
Should You Pay Off Your Mortgage?
While there can be several factors that influence retirees’ decision to pay off their mortgage, one factor is whether your mortgage interest rate will exceed the rate you can earn on CDs, money market funds, and bonds. Lower interest rates on these investments can tilt that decision factor in favor of paying off your mortgage.
How Should Retirees Move Forward?
Interest rate fluctuations are one good reason to diversify your sources of retirement income. Ideally, you’ll have significant sources of retirement income that aren’t influenced by interest rates. This is one good reason to optimize your Social Security benefits and other sources of guaranteed retirement income, such as pensions and annuities.
In addition, it’s a good idea to reexamine any outstanding loans you have. For instance, it’s always a good idea to reduce credit card debt, since the rates credit card companies charge far exceed other consumer loan rates, even with the recent rate cut.
You may also want to examine whether lower interest rates can make it worthwhile for you to refinance your mortgage or take out a reverse mortgage. However, if you believe that future rate cuts are in the cards, you might decide that you’d reap more money by waiting.
Part of your retirement job is to continually monitor key economic events and consider how they might affect your finances. By doing so, and making the right changes to your finances, you could improve your finances by many thousands of dollars.