Here are some smart moves to make ahead of a potential Federal Reserve rate cut. Getty Images/iStockphoto
Inflation is calming, which suggests the Federal Reserve may soon cut the federal funds rate. The Fed adjusts this benchmark interest rate depending on economic conditions, and most experts agree that a cut is likely before the end of the year.
This is important because changes in the federal funds rate are typically accompanied by changes in the interest rates that financial institutions charge consumers for loans and pay out on deposits. If the Fed lowers the federal funds rate, yields on deposits may fall, but so will loan payments.
You should also consider the possibility of upcoming interest rate cuts when making financial decisions. Here's what to do and what not to do if a potential interest rate cut is looming.
Take advantage of today's high CD rates now.
3 things to do (and 3 things to avoid) before interest rates are cut
With interest rates likely to fall in the future, there are some financial steps you should take now.
Opening a CD
With interest rates expected to fall in the coming years, it may be a lucrative move to take advantage of certificates of deposit (CDs) to lock in high yields today. These are fixed-interest savings accounts that guarantee a fixed interest rate for the entire term.
Of course, you'll usually also have to ensure that your money remains in the account until maturity; if you withdraw money before the account matures, you could be penalized. That said, CDs can be an attractive way to lock in today's high interest rates for months or years. And with the possibility of interest rate cuts looming, this could be worthwhile.
Don't wait until interest rates drop: lock in your CD yields now.
Choosing a HELOC over a mortgage
Are you planning on tapping into your home equity? A home equity loan and a home equity line of credit (HELOC) are two popular options you can choose from. However, with the prospect of lower interest rates, it may be best to choose the latter.
HELOCs usually have variable interest rates, while home equity loans usually have fixed interest rates. And because interest rates may be reduced in the future, choosing a variable rate over a fixed rate can save you a lot in the long run.
Limiting the risks of variable rate savings
Savings accounts offer more flexibility than CDs, allowing you to withdraw money when you need it, which is important for emergency savings. But with interest rate cuts looming, you'll want to limit your exposure to variable rate savings. Think about how much you need for emergency savings, and consider locking in a high fixed rate yield on the rest of your money in a CD.
“Aim to save enough to cover three to six months' worth of expenses to prepare for unexpected financial hardships,” explains Justin Stivers, financial advisor and founding attorney at estate planning and asset protection law firm Stivers Law. But once you've saved that amount in a variable-interest savings account, such as a high-yield savings account, you should consider opening a CD with the rest of your savings to lock in your current interest rate.
Three things to avoid before interest rates are cut
While there are things you should do to prepare for a potential interest rate cut, there are also some financial transactions you should avoid, including:
Focus on short-term CDs
When you open a CD, you can choose between short-term or long-term options. Short-term options usually mature within a year, while long-term options often take several years. Because interest rates may be lowered in the future and current interest rates are high, you may be better off locking in a current high interest rate for several years rather than choosing a short-term option.
Selling gold holdings
The possibility of interest rate cuts has to do with the fact that inflation is subsiding, and since gold is a strong inflation hedge, you may be tempted to sell your gold investments, but inflation is not the only reason to have gold in your portfolio.
Gold is a safe haven. It is safe against inflation as well as other market risks. During the current geopolitical situation and upcoming elections, it is a good idea to maintain a healthy exposure to safe havens. Hence, selling your gold holdings may be a mistake.
Lock in your fixed mortgage interest rate
If you're looking to buy a new home, you may be weighing fixed-rate vs. adjustable-rate options. However, with interest rates expected to fall in the future, an adjustable-rate mortgage (ARM) may be a better choice than a fixed-rate mortgage. Choosing an ARM could allow you to take advantage of future interest rate reductions sooner than by refinancing a fixed-rate loan.
Learn more about your mortgage options today.
Conclusion
It's important to adjust your financial plan if you expect interest rate cuts, which can affect your savings yields and borrowing costs. But you can protect your yield by opening a fixed-rate, long-term CD. Also, limit your floating-rate savings exposure. If you plan to borrow against your home equity or buy a new home, consider floating-rate options that could add to your savings later. And don't start selling your gold holdings just yet. Gold can provide valuable protection against market risks other than inflation.
Joshua Rodriguez