Through the ongoing COVID-19 crisis, we are committed to providing you with the resources you need to navigate through this difficult time. With the recent news of the Fed announcing it will be dropping interest rates to zero, Paul O’Donnell, Chief Credit Officer of Marlette Funding, servicer of Best Egg Personal Loans Platform, shares what this means and how it affects your finances.
The COVID-19 outbreak is a situation unlike any that we have faced and it continues to present risks, both to our health and to the economy. As hospitals and healthcare workers are risking their lives on the front lines, the Federal Reserve is taking drastic measures to keep the economy afloat as some businesses and entire industries come to a screeching halt.
In addition to providing emergency funds to government and private sectors, one of the major changes we’ve seen is the Federal Reserve dropping interest rates to zero. This change can be confusing, so we wanted to answer some general questions on what this adjustment means and how it can impact you.
To start, what is the Federal Reserve?
The Federal Reserve Bank (now known as the Fed) is the central bank of the United States and can be considered the gatekeeper of the economy. By law, all banks are required to keep a percentage of all of their deposits from customers as a reserve balance in an account at the Federal Reserve Bank. The Fed lends this money out to banks to then lend out to consumers and businesses. The Fed charges an interest rate called the Fed Funds Rate.
What does it mean for the Feds Funds Rate to go down to zero?
When the Fed Funds Rate goes down, it means that the lending costs to the banks go down. Because banks still have additional costs beyond the Fed Funds Rate, the consumer generally never sees long term interest rates of 0%. Still, the Fed Funds Rate can mean lower interest rates for consumers, especially for people who currently have variable-rate loans such as credit cards or for those who want new loans like mortgages or home equity loans.
Why does the Fed cut rates?
The Federal Reserve cuts interest rates to help the economy grow. By cutting the Fed Funds Rate, it reduces bank lending costs and eventually lowers the costs for certain types of loans such as business loans, mortgages, home equity loans, and variable-rate credit cards. This in turn, makes it more affordable for businesses and consumers to finance purchases that might otherwise have been too expensive.
Does this mean credit card interest rates drop?
Credit cards usually have variable interest rates that adjust based upon something called the Prime Rate. The Prime Rate is generally 3% plus the Fed Funds Rate. So when the Fed lowers its rate, the Prime Rate usually goes down along with any other variable loans that are based on the Prime Rate. The average variable rate charged to consumers is the Prime Rate + X%.
Keep in mind, interest rates are what cover the costs of lending and the Prime Rate is the lowest rate a bank can charge their very best customers (those that are highly likely to repay their loan). Banks still have additional costs to lend money and want to make some profit as well, which means rates may not drop much.
How does a lower credit card interest rate affect my finances?
When rates drop, assuming you are in a variable-rate credit card product, the amount of interest you pay and your monthly payment will be less. The loans that are most likely affected by the Fed Fund Rate cut include business loans, mortgages, home equity loans, and variable-rate credit cards. Sometimes credit card products have rate floors, meaning a rate that was disclosed as the lowest rate that would ever be charged – so even with a variable rate product, you may not see any reduction in interest rate.
Throughout this crisis, our team is closely monitoring updates from the Fed and other government officials on what other changes they’re making to have a positive economic outcome for both businesses and citizens. We understand that this is a confusing time and we want to be there to help navigate you through it. For more, continue to check our blog or follow us on Facebook, Twitter, and Instagram to stay up to date on the resources we’re providing.