In December 2024, the Federal Reserve reduced its benchmark interest rate, marking the third consecutive cut this year. As a result, interest rates on credit cards, loans, and deposit products have been falling as well — good news for borrowers, but not so great for savers. That’s a stark contrast to earlier this year, when it was more expensive to borrow money, but you could also earn above 5% on your savings.
Understanding the pros and cons of high versus low interest rates is key to making informed decisions, whether you’re saving for the future or managing debt. So, do we want higher or lower rates? The answer isn’t exactly simple.
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The Federal Reserve is mandated by Congress to promote stable prices and maximum employment within the US economy. One of the tools it has at its disposal to achieve these goals is the federal funds rate.
During times of high inflation, for instance, the Fed will raise its federal funds rate, which is the rate banks charge each other for overnight loans to meet cash reserve requirements.
When the federal funds rate increases, financial institutions also increase interest rates on certain types of loans, such as credit cards, auto loans, personal loans, and, less directly, mortgages. Many of them also increase the interest rates on their savings products to expand their lending capacity. This makes it more expensive for Americans to borrow money, but it also means they can earn more on their savings balances.
On the other hand, if the Fed wants to stimulate economic growth, it will lower the federal funds rate. When this happens, loan interest rates also go down, encouraging borrowing and spending among consumers and businesses. The downside is that deposit accounts pay less interest, stunting savers’ ability to grow their savings.
Read more: Fed rate cut: How it affects your bank accounts, loans, credit cards, and investments
Depending on your situation, higher interest rates can either help or hurt your financial well-being. Here are some benefits and drawbacks to consider.
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Better savings rates: If you have a lot of cash in savings, you may benefit from higher rates. In some cases, high-yield savings accounts can offer rates roughly 10 times the national average (or higher).
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No impact on existing fixed-rate loans: If you took out a loan with a fixed interest rate before market rates started to climb, your monthly payments won’t be impacted.
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Incentivizes financial discipline: Higher borrowing costs can help discourage taking on impulsive or unnecessary debt, prompting you to focus more on budgeting and saving.
Read more: 10 best high-yield savings accounts available today
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New loans are more expensive: If you take out a new loan when interest rates are elevated — whether it has a fixed or a variable interest rate — you’ll be charged a higher APR, even if you have excellent credit. This may translate to higher monthly payments, spending more in interest over the life of the loan, and/or having to take out a smaller loan to compensate for the increased costs.
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Tighter budget: Larger monthly payments on your loans and credit cards could put a strain on your budget, making it more difficult to cover your essential expenses and keep up with debt obligations.
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Other financial challenges: The Fed often increases interest rates during periods of inflation, which means that you could be struggling in other areas of your budget. Minimizing debt is crucial during these periods of economic turmoil.
Read more: How to protect your savings against inflation
While there are clear benefits to lower interest rates, there are also some potential disadvantages to keep in mind.
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New loans are more affordable: If you take out a loan or credit card during a period of low interest rates, you can expect a lower monthly payment, which puts less of a strain on your budget. Plus, you’ll pay less in interest overall.
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Variable-rate loans may become cheaper: If you have a credit card or other type of variable-rate loan, your interest rate will typically start to come down soon after the Federal Reserve cuts interest rates. Lower payments can give your budget some more breathing room.
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Refinancing opportunities: If you took out a fixed-rate loan during a period of high interest rates, you may have the opportunity to refinance your debt with a lower interest rate, reducing your monthly payment and saving money on total interest charges.
Read more: Is now a good time to refinance your mortgage?
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Savers won’t earn as much: With lower interest rates, you likely won’t earn much on your savings account, money market account, or certificate of deposit (CD).
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Possible strain on retirees: Those who rely on interest income from savings and bonds will see reduced returns, which could impact their ability to cover living expenses.
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Risk of inflation and asset bubbles: When interest rates are lower, spending generally increases, which could cause prices for goods and services to rise. Additionally, lower borrowing costs can lead to inflated prices for real estate and other assets.
Read more: How to maximize your savings following the Fed’s rate cut
There’s no right answer when it comes to whether a high or low interest rate environment is best. Ultimately, it depends on what is best for the current economic situation, as well as your personal financial goals and needs.
Typically, low interest rates are best following an economic downturn when the Fed needs to stimulate economic activity. At the individual level, low interest rates are ideal if you’re interested in taking out a large loan (such as a mortgage) or could benefit from refinancing an existing high-interest loan.
On the other hand, high interest rates are good for managing inflation and stabilizing prices. If you’re trying to save more money and looking for low-risk ways to grow your wealth, higher interest rates can help too.
The Fed slashed the federal funds rate three times in 2024 for a total of 100 basis points (or 1%). However, interest rates remain high by historical standards. What’s more, the inflation rate’s downward trend has stalled in recent months.
As a result, the Fed indicated it may be more cautious about future rate cuts. So what does that mean for you and your money? Here are some steps you can take to make the most out of the current interest rate environment:
If you don’t have a high-yield savings account, you may not be benefiting from elevated savings account rates. Although these rates will go down over time as the Fed continues cutting the federal funds rate, it’s unlikely to happen quickly. And even in a low-rate environment, high-yield savings accounts remain one of the best options for earning the highest return possible on your savings.
Unlike savings accounts, CDs allow you to lock in a specified interest rate for a set period of time. CD terms can be anywhere from one month to several years in the future. However, be sure to choose a CD term that fits your savings timeline, as withdrawing your money before the maturity date will result in a penalty.
Read more: The best CD rates on the market today
While the inflation rate is still elevated, it’s important to minimize your expenses where possible so you can avoid taking on more debt than necessary.
If you’re thinking about buying a home, it’s important to note that mortgage rates aren’t directly influenced by the federal funds rate like other forms of debt. Instead, mortgage lenders use the 10-year Treasury yield as a benchmark.
While the federal funds rate has some influence on the 10-year Treasury yield, Fed rate cuts won’t necessarily result in lower mortgage rates, so don’t jump into a home unless you’re absolutely ready.
Read more: How the Federal Reserve rate decision affects mortgage rates
