Navigating Low Interest Rates: What to Know

The economic conditions across the country can have an important impact, even if not immediately obvious, on your finances. One key factor is how high or low interest rates currently reside. Where these sit can drive crucial decisions, such as whether you buy a house, where you invest your money, or how you approach debt.

From September 2022 until July 2023, the Fed has raised interest rates 11 times to curb a rising inflation rate, with them holding between 5.25% and 5.5% since that time. On September 17th through 18th, however, the Federal Open Market Committee is meeting to determine the federal funds rate. In addition, many speculate that rates are set to fall because of lowering inflation rates, dropping from a high of 9.1% for all items in July 2022 to 2.9% in July 2024, per the Consumer Price Index (CPI).

In this article, we investigate what drives the Federal Reserve to lower interest rates. We’ll also break down the implications of an interest rate drop and what you should consider if that happens. Additionally, you’ll learn how the help of a financial advisor can be invaluable for navigating constant changes in economic conditions.

Why Interest Rates Fall

Interest rates are fluid, constantly rising or falling in reaction to economic conditions. According to Thomas J. Brock, CFA, CPA, an expert contributor at RetireGuide.com, “The primary determinant of interest rate levels is the federal funds rate, the overnight lending rate for depository institutions and the foundation for all longer-term lending arrangements.” Per Brock, the “U.S. Federal Reserve uses this rate to influence domestic monetary conditions and achieve its dual mandate of minimizing unemployment and maintaining price stability.”

Each year, the Federal Open Market Committee (FOMC), a group of 12 banking leaders in the United States, typically meets on eight occasions to discuss and set the federal funds rate. Brock explains that the Fed will often lower interest rates during “periods of high unemployment and low inflation” and raise them in the face of “low unemployment and high inflation.” The former increases “borrowing demand” and increases “the velocity of money,” whereas the latter curbs “demand” and “cools off the economy,” says Brock.

Positive Implications of Lower Interest Rates

When interest rates are lower, many benefits can help people’s finances. For instance, you’ll be able to get a loan, such as for a mortgage or car, at a more favorable rate, saving you money in the long term.

Below is an overview of the various benefits one might expect in a low-rate environment:

Easier to Borrow Money and Pay Off Debt

One of the key benefits of lower interest rates is that people can borrow money more easily. More generous rates make people more likely to take on debt than during periods of high interest. For instance, you might be more inclined to buy a house or, if you already did during a time of high interest, refinance at a more favorable rate.

Higher Real Estate Prices

Low interest rates can also benefit real estate owners because they often raise property values. Because people can borrow at a better rate, the demand for homes typically goes up as a result. This allows homeowners to command a higher price for their properties than during periods of high interest.

Overall Economic Growth

As Brock explains above, the intent behind lowering interest rates is to stimulate the economy and drive demand across various markets. When people can borrow more, they typically can spend more on consumer goods and services, boosting economic growth. Additionally, many might opt to invest in company stocks due to rates dropping for savings accounts and certificates of deposit (CDs).

Additionally, economic growth could result in more jobs and a lower unemployment rate in the U.S. For example, in response to the COVID-19 pandemic, which resulted in a peak of 14.8% of Americans being unemployed, the Fed opted to lower the federal funds rate to 0.25% from March 2020 to February 2022 to boost jobs.

Negative Impact of Lower Interest Rates

While lower interest rates can be beneficial to most Americans, there are still negative implications to weigh. Being able to borrow money more easily, for example, can be a paradox that leads people to take on more than they can handle.

The following list is an outline of the disadvantages of dropping rates:

Savings Accounts Yield Less

An important factor to consider when interest rates fall is the reduced yield from your savings and money market accounts, as well as new CDs. As a result, you may feel compelled to reconsider where you’re keeping your cash.

How far might savings accounts fall? As an example, imagine you have a high-yield savings account (HYSA) that’s currently set at 5.5% APY. Based on a prediction by CBS News earlier this year that suggests a rate drop of 0.75%, your HYSA would potentially drop to 4.75%.

Inflated Asset Prices

In the previous section, we noted that the potential increase in real estate demand and price benefits homeowners, but it could also be to the detriment of homebuyers. As prices rise, it could be much more difficult for first-time homebuyers to get their foot in the door with an initial down payment.

Borrowing Money Could Be Tempting

It can be very tempting to take on different types of debt at lower interest rates, but Brock emphasizes that “debt loads can become unmanageable at any interest rate level.” For this reason, he says, it’s “imperative to use debt sparingly and only when it enables you to comfortably improve your lifestyle and/or acquire assets that appreciate in value (as a consumer) or generate an acceptable return on commercial endeavors (as a business owner).”

What Should You Do After Interest Rates Drop?

Many people stand to benefit from a decrease in the federal funds rate, however, it’s important to evaluate how it might impact your financial plan and, if necessary, adjust. We recommend that, either before or after such a change, you speak with a financial advisor and weigh the benefits and costs of what to do next.

With that being said, there are many ways you could react to a drop in interest rates. What you do depends largely on the debt you already have, where you keep your investments, and whether you own a home. Below are some key points to consider (which your advisor may recommend) after a decrease in the federal funds rate:

• Assess where you keep your cash. During times of high interest, it’s common for people to store money in HYSAs or CDs. However, low rates might make it more beneficial to invest in stocks or bonds to gain a better yield.
• Weigh the benefits of refinancing your home. If you bought your home during a high-interest period, refinancing could allow you to get a better mortgage rate. Be sure to consult with your advisor about how this may benefit you.
• Don’t rush into debt. As Brock explains, it’s crucial not to take on too much debt, even at lower rates. Owing too much money could easily put you underwater financially.
• Consider whether it’s time to sell real estate. Periods of low interest can result in higher real estate demand and prices. It might be time to talk to an advisor about whether selling your real assets could benefit you.

No matter the impact of low interest rates on your finances, we recommend you consult with a professional to ensure you have the proper plan in place. Strategies that work for some may not work for you, which makes it imperative to receive personalized financial advice. To find an advisor near you, consider using this free matching tool, which will pair you with a vetted fiduciary expert tailored to your needs.