In an effort to aid the economy. the central bank of the United States - known as the Federal Reserve - recently issued another emergency rate cut amid the coronavirus crisis, slashing rates to nearly zero.
A rate cut from the Fed is a sign that the economy is slowing. In economic downturns, the Federal Reserve cuts interest rates in an effort to help propel growth. Conversely, when the economy is trending upward, the Fed raises rates to help reduce inflation. However, this economic downturn is unlike anything we’ve seen before and even the Fed’s rate cuts don’t seem to be having the traditional effects.
“The Fed is trying to do the right thing by offering people lower access to capital, but since they did it so rapidly in such a unique time, it’s caused the underwriters to be afraid and raise rates in many cases,” said Joseph Toms, President & Chief Investment Officer at Freedom Financial Asset Management.
As for how the rate cut and the virus are working together to impact the interest rates on specific financial products, that varies. Here’s what you can expect to see across the industry.
Credit card rates
Most credit cards have variable interest rates and the rate that you're given is tied to the prime rate, or the rate that most banks charge consumers with excellent credit. Since the prime rate is based on the Fed funds rate, you’d usually see credit card rates go down after a rate cut. However, that isn’t the case this time.
“Credit card rates have gone up in many cases,” asserted Toms. “If they haven't, [the credit card companies] are ‘tightening the box,’ which means they’re not letting as many people access the best rates. Maybe, before, FICO scores of 640 could get those rates, but now only scores of 720 or higher can get them.”
For cardholders, this means that they could see higher interest charges than usual on their credit card debt, especially if their credit score isn’t the best.
Savings and certificates of deposit rates
A fed rate cut, on the other hand, is typically disappointing news for savers. When rates are cut, banks usually choose to lower the annual percentage yields (APY) on products like savings accounts and certificates of deposit (CDs) alongside them.
Toms noted that this action usually has a stimulating effect on the economy. When savings accounts and CDs are not earning favorable rates, consumers will typically go out and invest in riskier assets in search of better returns, which provides much-needed capital.
“The usual effect of [Coronavirus] is that nobody wants to take more risk,” he said. "Even though people are not earning any interest, they want to keep their money in a safe place like those savings accounts and deposits.”
For their part, mortgage rates don’t always mirror Fed rate cuts. Instead, interest rates on home loans are impacted more by the 10-year Treasury yield, which plays a large role in determining the 30-year fixed mortgage rate.
With that in mind, even though mortgage rates were at historical lows at the beginning of March, they’re going back up. Part of that rise, according to Toms, is due to the surge in refinances that we saw last month as rates went down.
“Banks suddenly had too many applications in hand and were unable to sell all of them as mortgage-backed securities, which is how they get liquidity,” he explained. “Individually, lenders have begun raising rates to try and fix the supply-and-demand issue, but all of them are doing it.”
That might soon change, however, because the Fed has recently pledged to buy at least $200 billion in mortgage-backed securities, which would provide the banks with the capital they need to take on more loans.
Home equity lines of credit
By the same token, homeowners who are looking to weather the storm of Coronavirus by taking out a home equity line of credit may have a harder time qualifying, despite the rate cut.
“From a collateral standpoint, a mortgage comes first and a HELOC comes second,” he explained. “When banks aren’t sure what’s going to happen, they don’t want to risk not getting paid on that second loan.”
To that end, JP Morgan Chase, one of the largest financial institutions in the country, announced that it is no longer accepting HELOC applications.
Student and personal loans
While those with federal student loans are likely benefiting more from President Trump’s announcement to halt the collection of student loan payments for 60 days than the rate cut, those with private student loans may see some improvement in their interest rates.
Personal loans are a different animal altogether. Toms said their trajectory is more similar to mortgages than to student loans.
“[Personal loan] lenders are under tremendous pressure because their partners who buy the loans are nervous. They’re forcing the lenders to raise rates and tighten credit standards as a precondition for them to buy the loans,” he said.
“Again, the unfortunate impact of Coronavirus is that available loans are being pulled away from consumers who probably need them more than ever.”