September 27, 2019
Lower interest rates are here again! The Federal Open Market Committee (FOMC) met on September 17th and 18th for the third time since the start of the summer to discuss economic expansion and current labor market conditions in the United States. During this two-day meeting the Federal Reserve (Fed) decided to cut the federal funds rate for the second time this year, leading banks to follow suit and reduce the prime rate from 5.25% to 5%. Confused about the difference between the two rates? You’re not alone. Many consumers are wondering what this change means for them and their finances.
What Is the Prime Rate?
The prime rate is the gold standard for what banks will charge their most creditworthy customers – typically those who are less likely to default on payments. Although banks are not mandated to follow these benchmarks, many choose to through incentives given from the nation’s Central Bank. It’s a common misconception that the Fed establishes the prime rate, but that isn’t quite the case. In reality, the Fed sets the federal funds rate, which is the rate that banks will charge each other for overnight loans. The prime rate, officially called the WSJ Prime Rate (WSJ stands for Wall Street Journal) is determined by a survey of the nation’s 30 largest banks. When 75% of them (23) change their rates, the prime rate is adjusted to match. A change in prime rate is typically a direct result of the federal funds rate changing.
Why Did This Change Occur?
The Fed regularly meets with the FOMC to measure economic indicators and to decide whether to increase or decrease the federal funds rate, based on a variety of factors. The FOMC’s purpose is to adjust this rate to further support economic prosperity and growth. According to the Federal Reserve FOMC statement on September 18, 2019, the outcomes of the latest decrease will be “sustained expansion of economic activity, strong labor market conditions, and inflation”. Basically, the Fed wants to ensure the economy stays strong and reducing interest rates is one way to do that.
What Does the Prime Rate Affect?
If you have a credit card or a home equity line of credit (HELOC), chances are it will be affected by the prime rate. The majority of credit cards and variable rate home equity lines use the prime rate as a standard to determine your current rate at any given time. This means changes to the prime rate can lead to an increase or decrease in your minimum monthly payments as that rate fluctuates. The latest decrease will likely result in a rate reduction on bank offerings such as auto loans, and even adjustable student loans. Since banks will likely charge a lower rate on their loans, expect that rates on interest earning accounts, such as savings, certificates of deposit, and money market accounts could also be reduced by prime rate changes.
What Does This Mean for You?
As a consumer, a lower prime rate means borrowers could expect to see a reduction in their annual percentage rate or APR on their credit card or HELOC within a couple of billing cycles. Since this is the first back-to-back rate cut since 2008, now is the best time for consumers to shop around for various loan products. If you are planning on purchasing a new car, the Fed rate drop could lower future financing and manufacturing costs on cars, producing favorable rates for consumers. If you already have a credit card or loan with a variable rate it could mean that, even if your payments don’t change, more is being applied to the principle rather than the interest.
If you’ve been considering a large financial move, such as buying a car or renovating your home, now may be the time to lock in a low rate. Begin by thoroughly researching loan offers and talking to your bank about their current rates. By doing some simple searches online or checking out your bank’s website you could potentially find an unbeatable loan! The options are endless, as long as you pay attention to the prime rate and know how it may impact you.
Keep in Mind
Although the prime rate is the lowest it’s been in over a decade, it’s important to keep in mind that there is no guarantee for how long low rates will stick around. Don’t hesitate to reach out to your local bank to learn more about the options available to you. Time is of the essence, with another FOMC meeting quickly approaching in late October, you don’t want to miss out on the opportunity to take advantage of a great deal!
Jim Oosterman is the Senior Vice of Melrose Bank and a lifelong resident of Melrose. He can be reached by telephone at 781-665-2500, online at melrosebank.com, or on Facebook at facebook.com/MelroseBank.