Credit cards and savings accounts are most sensitive to changes in the federal funds rate, followed by personal loans and auto loans, and finally, mortgage loans. The interest rates on all of these products are determined by other important factors, such as creditworthiness.
As the Federal Reserve interest rate is a short-term rate, changes in it have a stronger impact on short-term lending products. They also tend to have a bigger impact on products with variable, rather than fixed, interest rates.
Here’s how banks set the interest rates on credit cards, loans, and savings accounts and how changes in the federal funds rate might affect you.
Credit card interest rates
Fluctuations in the federal funds rate have a direct impact on credit card interest rates. This is directly tied to the prime rate, which is the interest rate for customers with prime credit, and it’s pegged at 3% above the federal funds rate.
Furthermore, since credit cards are the most short-term borrowing method, the rates will change almost immediately in response to federal funds rate changes. However, because interest rates on credit cards are relatively high, these changes — for example, your APR going from 17.25% to 17.50% — are often unnoticeable.
Personal loan interest rates
The interest rates on personal loans aren’t directly tied to the prime rate or the federal funds rate, but they can be influenced by it. In other words, changes in the federal funds rate can eventually lead to changes to personal loan rates, but that correlation is neither as guaranteed nor as immediate as it is with credit cards.
What’s more, many personal loans have fixed interest rates, meaning if you already have a personal loan, the rate will remain the same for the life of the loan — regardless of how the fed funds rate changes. Loans with variable interest rates can fluctuate as the fed funds rate changes.
Auto loan interest rates
Like personal loans, auto loan interest rates aren’t directly tied to the federal funds rate. However, they can be influenced by it, particularly because they’re somewhat short term — typically two to five years. The changes in auto loan rates are likely to be minimal though, as they’re largely based on other factors like your credit score and the bond market.
Mortgage loan interest rates
Mortgage loans are one of the most long-term ways you can borrow money, so short-term interest rate changes aren’t likely to affect them much. In fact, mortgage rates aren’t directly tied to the federal funds rate — they’re set based on a variety of economic indicators, which can include the federal funds rate, but also include things like unemployment, inflation, and the bond market.
Savings account interest rates
Interest rates on savings accounts are fairly responsive to changes in the federal funds rate. When interest rates are cut, banks are likely to cut the APYs offered by their savings accounts fairly quickly in order to protect their profits. Increases in the federal funds rate usually lead to less dramatic and immediate increases in savings account rates, but a rising rate environment is still advantageous for savers.
The Federal Reserve interest rate is an important tool for guiding the economy. Increases in the federal funds rate can protect a strong economy, while cuts to the federal funds rate can help cushion the fall for a declining economy. These changes can impact your wallet — low interest rates are good for borrowers, while high interest rates are good for savers. Ultimately, though, it’s your own money habits that are the main factor in determining your financial future.