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Federal Reserve Interest Rate Cut and Your Personal Finance

28 February 2008 6 Comments

Last month was a busy month for stock market as Federal Reserve or the Fed made emergency interest rate cut from 4.25% to 3.5% due to the global plunge in the stock market. This is the first time Fed has changed the funds rate between the meetings since 2001 and this news has become the hot discussion topic for the media.

According to the news here, the Fed would cut interest rates again at its next meeting, on March 18. The interest rate cut has been made by Fed lately to help the US economy. You may read a lot of news on this. Do you really understand the true meaning behind the interest rate cut and what it really means for your personal finance?

 

The Role of Federal Reserve

Federal Reserve, also known as Federal Reserve System or The Fed, is the central banking system in United States. The primary job of the Fed is to control the inflation while avoiding recession. In a nutshell, it is a system to control the US economy.

All the banks in US are mandated to keep a certain amount of reserve balance in the local Federal Reserve branch office. This becomes the famous Federal Reserve Funds and the Fed has the power to raise and lower the interest rate for these funds. This interest rate will be charged on the banks if they borrow money from these funds.


Fed Interest Rate Cut, What does it means to you?

Ok, the boring part is over. Now let us discuss the main point that how Fed Interest Rate Cut will affect your personal finance.

Generally, the Fed Interest Rate directly influences the short-term interest rate products such as deposits, loans, credit card interest rate or even your adjustable-rate-mortgage (ARM).

Without further ado, below are the main Fed Interest Rate effects on your personal finance:

  1. Business Loans. Each month the Fed will hold a meeting to discuss and announce a specific level for the federal funds rate. A higher Fed funds rate or interest rate means banks are less willing to borrow money from the Fed funds. Therefore bankers will charge a higher interest rate on the money they lend out at this time. So if you get a business loan or personal loans at this moment, you will have to pay a higher interest rate which might make your cash flow out of control. So choose the right time to get the loans is one of the skills that you and I should learn.
  2. Housing market. Fed Interest rate also affects the housing market. Lower interest rate will make the ARM has lower interest rate. Of course this is also the right time to buy houses and properties. If you want to become a real estate investor, then you have to do some home works to understand the economy and hence predict the Fed’s decision on interest rate. This will help you to make a better decision and have a better investment strategy. At least you will know which kind of mortgage you can choose to maximize your investment returns.
  3. Trading Market. If you ever involved in trading such as stock or Forex market, you will understand that it is very important for you to follow the news of Fed interest rate. A 0.25 point of interest rate declination will not only stimulates the economic growth, but also sends the markets higher in jubilation. Lower interest rate can help in inflation and local business environment. Good business environment will help companies make more money and hence increase the stock prices since stocks directly related to the companies’ performance.  This is a chain cycle effect of Fed Interest rate and stock market.
  4. Loan Consolidation. As I said just now, the interest rate of the loans will be lower due to the interest rate cut. So this maybe a good time for you to consolidate your loans such as credit card debts, personal loans or mortgage to a lower interest rate loans. However, please be careful in this process. However, please be careful in this process. My advice is please don’t take any loans before you really do the calculation and confirm that you are paying less after the consolidation. There are a lot of traps on calculation for consolidation. You can ask the bank officers to do the “clear” calculation for you or ask around on the internet to get some helps on this if you don’t really understand how interest rate works.

 

My Advice…

The Fed’s decision is very important for every one of us. This is part of the financial literacy that I recommend all people should understand before we take action to apply loans or invest money in stock and real estate market.  It is directly affecting our money. So if you want to read more about how Federal Reserve works, you can visit this site. Please understand everything first before making any serious decisions.

Update : This post was listed in Carnival of Personal Finance #142

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6 Comments »

  • Wai Ling said:

    Just in case you are interested to learn from the minutes of previous FOMC why FED decided to cut interest rate. Enjoy…

    Source: Briefing.com

    Fed Brief - In depth analysis of Federal Reserve Policy.

    Updated: 20-Feb-08 14:43 ET

    January Minutes and Conference Calls

    The January 30 FOMC minutes also contained the details of the conference call that preceded the January 22 intermeeting 75 bp ease. The strong 1.25% ease over those nine days came as the committee saw ’significant’ risks of a downturn and ‘disappointing’ inflation data. The committee noted that financial markets remained under considerable stress, that credit had tightened further for some businesses and households, and that recent information pointed to a deepening of the housing contraction as well as to some softening in labor markets. The Committee again viewed it as appropriate to indicate that it expected inflation to moderate in coming quarters but also to emphasize that it would be necessary to monitor inflation developments carefully.

    On January 21, 2008, the Committee met by conference call. Incoming information since the conference call on January 9 had reinforced the view that the outlook for economic activity was weakening. Among other developments, strains in some financial markets had intensified, as it appeared that investors were becoming increasingly concerned about the economic outlook and the downside risks to activity. Participants discussed the possibility that these developments could lead to an excessive pull-back in credit availability and in investment. All members judged that a substantial easing in policy in the near term was appropriate to foster moderate economic growth and reduce the downside risks to economic activity. Most members judged that an immediate reduction in the federal funds rate was called for to begin aligning the real policy rate with a weakening economic situation. An immediate policy action could be misinterpreted as directed at recent declines in stock prices, rather than the broader economic outlook.

    The revised 2008 Fed projections lowered real GDP growth to 1.3%-2% (from 1.8%-2.5%), raised expectations for the unemployment rate to 5.2%-5.3% (from 4.8%-4.9%) and raised the core PCE inflation range to 2%-2.2% (from 1.7%-1.9%). The new growth forecasts are considerably lower than November given the downside risks. The Fed expects growth to reaccelerate in 2009 and 2010 as core inflation moderates over the next two years. Some on the committee foresaw possible ‘rapid reversal’ of rate cuts given the current need for ‘relatively low’ interest rates.

    The January Fed Statement noted that “downside risks to growth remain” — fueling expectations for more of the same type of easing at the March 18 meeting.

    The Fed presidents stepped in with another dissent after official mixed opinion at the last three policy ease decisions. Today it was Dallas Fed president Fisher who dissented in favor of no ease at all. St. Louis Fed president Poole dissented last week in favor of waiting for the scheduled meeting. Boston’s Rosengren dissented in December preferring a stronger 50 bp ease and Kansas City’s Hoenig favored steady policy rather than an ease in October. While Bernanke seems to enjoy the airing of various views, it carries a sense of a uncoordinated team at the helm of monetary policy direction. Take a lesson from the Patriot’s coach Belichick — a united team spreads confidence in it’s the ability to accomplish a tough job.

    # 29 February 2008 at 1:30 am
  • Harrison (author) said:

    Hi Wai Ling, thanks for your contribution to this article. I really learn a lot of from the information you put here. I really appreciate it. :)

    # 29 February 2008 at 7:16 am
  • Carnival of Personal Finance #142 - The Homeless Edition — The Baglady said:

    [...] Harrison from Finandom gives some tips on how the Federal interest rates affect our personal finance in Federal Reserve Interest Rate Cut and Your Personal Finance. [...]

    # 3 March 2008 at 3:50 pm
  • Sunday Review #10 - Lasting Wealth to Getting Rich Quickly! at Henricus said:

    [...] Harrison from Finandom gives some tips on how the Federal interest rates affect our personal finance in Federal Reserve Interest Rate Cut and Your Personal Finance. [...]

    # 10 March 2008 at 3:59 pm
  • Don’t Worry, Recession has Benefits Too : Finandom dot Com said:

    [...] Federal Reserve has already cut down the interest rate several times. If you read my article Federal Reserve Interest Rate Cut and Your Personal Finance, you will know its effect on your money. At least, credit card and mortgage interest rates will [...]

    # 26 May 2008 at 9:26 pm
  • Tore Toivicco said:

    Who controls Federal reserve?

    Submitted by Tore Toivicco

    Who controls Federal reserve?

    http://www.youtube.com/watch?v=NzLIz27GqWs

    Most important question in US history?

    http://www.usagold.com/federalreserve.html

    Federal reserve controls US income/ finance?

    http://library.thinkquest.org/03oct/00921/governmenttaxes.htm

    Is Ron Paul talking about this?

    -Tore Toivicco

    # 13 February 2009 at 11:40 pm

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