How lower interest rates affect your money and what you should do now

The Federal reserve just lowered interest rates for the first time since early 2022, and all signs point to additional interest rate cuts in the months ahead. But how low will they go?

More importantly, what do lower interest rates mean for your money and what actions, if any, should you be taking today?

With plenty of opinions circulating in the news and on social media, it’s easy to feel overwhelmed and a little anxious. Here’s what you need to know, how to think about interest rates, and, more importantly, the steps you should take.

What to do with your money when rates are falling

When thinking about how to make the right financial decisions, here are three simple questions you can ask to point you in the right direction:

• What do I want?
• When do I want it?
• What saving or investment vehicle has the right level of risk and appropriate return to help me get it?

By using these questions as a guide, you can avoid costly mistakes, make smarter financial choices, and feel more confident in your decisions.

And while interest rate changes can impact the broader economy, unemployment, and inflation, we're going to focus on the three main areas of our personal finances that we can control - debt, savings, and investments.

#1 - Managing debt

Lower interest rates = lower borrowing costs.

We’ll start to see reduced rates on car loans, mortgages, personal loans, credit cards, and even new student loans. However, if you have existing, fixed-rate loans, the loan won’t change unless you take action.

Here are some smart steps, and actions, you can take when it comes to managing your debt:

• Keep making payments: Always stay on top of your payments to avoid penalties and damage to your credit score.
• Consider refinancing: Look at refinancing existing debt such as mortgages, car loans, or personal loans. You’ll want to wait until rates have fallen far enough that you would get significant savings by refinancing.

Quick word on student loans: When it comes to student loans, be careful with refinancing especially if you have federal loans. Refinancing means you have to take out a private loan and you could lose the many benefits associated with federal loans (like income-based repayment, loan forgiveness, and more).

• Avoid costly mistakes: Make sure you understand the “gotchas” in refinancing loans. Refinancing isn’t free and there are often costs associated with doing so. Do your homework and make sure you understand the trade-offs (e.g. the lower rate and monthly savings vs costs and fees you have to pay).

If you do experience savings from lower debt payments, start thinking about how you will put those savings to work. If you can, look for ways to put the extra cash flow either back into any outstanding debt to supercharge repayment or into other savings or investment strategies that support your other goals.

The million dollar question: Should you wait for rates to drop before making a big purchase (car or home)?

Interest rates aren’t generally a big driver of car prices so you could benefit from lower rates if you can wait to buy. When it comes to homes, waiting comes with risks.  No one really knows what lower rates will do to home prices. If lower rates stimulate more buying and selling activity it could lead to more competition and higher prices. The bottom line, for bigger purchases it’s more about focusing on what you can control – saving for the down payment, planning for the monthly expenses, and buying when the time is right for you.

#2 -Managing savings

Even as rates fall, there are still smart strategies for putting your money to work. Generally, your savings strategies should focus on goals within the next 1 to 3 years.

Here are some appropriate savings vehicles to consider

• Checking and savings accounts: These accounts don’t pay much in the way of interest so you won’t see a major change. They are great options for everyday savings and your “operating accounts” (i.e. the ones you use to pay your monthly expenses).
• High-yield savings accounts: There will be an immediate change in interest rates, but they still serve as great accounts for things like your emergency fund or savings for any short-term goals. Rates can be as much as 10 times savings accounts so they’re a great place to put that extra cash.
• Certificates of deposit (CDs): As rates fall, you can lock in higher rates if you have a set timeline for an upcoming purchase or expense. However, with shorter-term rates higher than longer-term rates, longer maturity CDs may actually pay you less.

The goal for money to be used in the next year or two is to make sure the money will be there if and when you need it. You want to look at no or low risk vehicles and then find the best interest rate. It can be tempting to chase higher returns, but those higher returns often come with higher levels of risk.

#3 - Managing your investments

Interest rates do impact your investments.

Interest rates and bond prices move in opposite directions (called an inverse relationship). As rates go down, bond prices go up, and vice versa, all else being equal.

As for stocks, the relationship isn’t quite so linear. In reality, the strength of the economy and earnings growth matter far more than interest rate changes.

So what should you do? 

The biggest misconception with investing is that every investment strategy is designed for retirement which can be decades away. So people have cash for short-term goals and stocks for long-term goals. But what about the goals that are 5 years off? Or even 10 years off?

Investing doesn’t have to be all or nothing (i.e. cash for today and investing for 30 years). There are smart ways to put your money to work for those mid-range goals as well.

Here’s how to think about different investment solutions. Quick point of emphasis, remember that all investments come with risk so make sure you understand the risks involved with each investment and whether or not it’s right for you and your goals.

• Short-term bonds: Cash and high-yield savings accounts are great for expenses in the next several years, but what about those a little further out? This is where short-term bonds could play a role. Consider them for those goals that are 2 or 3 to 5 years away. But know that not all bonds are created equal so make sure you know how to choose the right bond investments.
• A more balanced approach: If there are goals in the 5 to 10 year window, consider creating a balanced strategy with a mix of bonds and stocks. The longer the time horizon, the more risk you can generally take, but, again there’s no magic formula for the right risk. It all depends on what is right for you.

Here’s a quick example: Let’s say you have a goal that is between 5 to 10 years away or maybe you don’t have a specific goal but you want to create some flexibility with how you use your money (i.e. create an “opportunity fund”). You could create a strategy that is 60% bonds and 40% stocks (adjust to your risk tolerance) so you balance the lower risk of bonds with higher growth potential of stocks.

• Stocks for the long haul: When it comes to achieving long-term investment outcomes your best course of action is to continue to invest in stocks for growth. In general, making big changes to your longer-term investment strategies isn’t recommended based upon short-term changes like interest rates, the economy, or inflation.

Taking the right actions is key

There will be a lot of noise in the media about where rates are going and what you should do with your money. When you feel a little overwhelmed or anxious (it happens to all of us), remember the three simple questions you can ask to help you get clarity around the right choices:

• What do I want?
• When do I want it?
• What saving or investment vehicle has the right level of risk and appropriate return to help me get it?

There are always many things you could do, but knowing what you should (and shouldn’t) do not only helps you cut through the noise and reduce the anxiety of uncertainty, but it also enables you to make smarter, more confident decisions that set you up for success.

Not sure where to start? That’s okay—most of us weren’t taught this stuff in school (or as adults). At Facet, we’re here to help you make smarter financial choices so you can spend less time worrying about money and more time enjoying life.

I am Brent Weiss, CFP®, Facet’s Co-Founder and Head of Financial Wellness. Facet Wealth is an SEC Registered Investment Advisor. The information provided is for educational and entertainment purposes and is not meant to be investment, financial, tax or legal advice. Investments have risks and there are no guarantees. Past performance is not a guarantee of future performance.