There's talk of interest rate cuts and you might be wondering how you'll be impacted.
Loans and Mortgages
When interest rates are cut, it directly translates to lower borrowing across the board. It might not immediately lower mortgage rates and other loan rates, but it eventually trickles down to all areas, even credit card rates.
Savings Accounts and Investment Portfolio
When it comes to savings and investing, interest rate cuts directly affect savings accounts interest rates, especially High Yield Savings Account (HYSA) and bond prices.
The impact on your savings account is straightforward: rate cuts means your bank borrows and loans money at a lower interest rate, so your account will also earn a lower interest rate.
It's not as straightforward with bonds!
There's an inverse relationship between bond prices and interest rates. Here's an explanation:
Think of bond prices and interest rates as being on either end of a seesaw. When interest rates go up, bond prices go down, and when interest rates go down, bond prices go up.
Here's why:
A bond that was priced at $1000 with a coupon rate of 10% gives the holder a $100 interest payment every year.
If interest rates go down and new $1000 bonds being issued now have a coupon rate of 8% (paying $80 a year), the holder of the 10% bond can sell their bond for more than $1000 because it pays $100 annually instead of $80 annually.
For instance, a buyer who buys the 10% bond for $1100, is happy because the interest rate will work out to be 9.1% ($100/$1100), which is better than the going rate of 8%.
The reverse would apply when interest rates go up.
It's important to note that this relationship applies to individual bonds. Bond funds are not as sensitive or directly correlated to rate changes.
Conclusion
Chatter about rate changes can lead to a lot of speculation, but knowing how it affects you will help you keep a clear head and make decisions that are right for you.
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