How Lower Fed Funds Rate Affects Savings Rates

What are Fed’s funds rates? 

The Federal funds rate is a specific number, or rate, set by the Federal Open Market Committee (FOMC), which is the group within the Fed that makes economic policies. This rate tells commercial banks the amount of interest — the “target rate” — they can charge to borrow and lend their reserve cash to one another. Banks are required to keep a certain amount of money in reserve at a Federal Reserve Bank; but any money they have over the required amount they are allowed to lend to other banks. The FOMC meets eight times a year to consider this rate, and can raise or lower it depending on the health of the U.S. economy. Changing the rate can help the economy to speed up or slow down as is needed to avoid inflation and recessions.

Why does the Fed change savings rates? 

The Fed raises and lowers interest rates — the Fed funds rate — to a target rate that tells banks the rate they should use when they make loans to each other. Why does the Fed change this rate? Lower rates of interest allow for economic growth, because banks and consumers are more likely to apply for loans, mortgages and other financial vehicles when interest rates are low. Stocks, too, are impacted by the lower rates, and the ripple effect is felt throughout the economy.

But if the Fed makes the rates too low, it can lead to growth that is too much, too fast. During times of inflation, the Fed will raise the rates slowly to counteract this excessive growth. As the rates rise, fewer consumers will want to take out loans because when interest rates are high, variable-rate loans such as student loans and mortgages will have higher monthly payments. The changes filter slowly from the banks down to your own savings accounts, CDs and money market accounts, as well, changing the amount you earn in interest. 

Balancing all the factors of the complex U.S. economy, the FOMC changes the Fed funds rate to keep the overall economy running. But the impact can be felt on an individual level. Your bank or financial institution may raise or lower the rate of interest that you’re earning on a CD or MMA if your rate is not “locked in” when you first sign up for it. Your savings account may earn less interest when the rate is low, and if you apply for a mortgage, car or home improvement loan when the rate is high, you’ll find yourself paying more in interest for the loan. 

How do lower Fed’s funds rates affect savings rates? 

A lower Fed funds rate — such as the one the FOMC mandated in March in response to the COVID-19 pandemic — typically means that your accounts will earn less interest. But that doesn’t mean you shouldn’t look for banks to invest with that are slower to respond to the new rate. 

Some banks, and especially online banks and credit unions, will let interest rates lag behind the Feds fund rate to attract customers, and that’s something you can use to your advantage. Spending some time online scoping out what banks are offering may make the difference in terms of the interest you may earn on a new CD, money market account or even a basic savings account. Or, if you prefer, you can hold onto your money until the FOMC meets again, potentially raising the rate to be more favorable to savers. 

On the plus side, low Fed funds rate periods are great times to take out a loan, because your lender will generally charge a lower rate of interest on the loan. If you’ve been house hunting, for example, you’ll find mortgage rates currently at less than 4% for 30-year fixed options. 

If you have invested your money in stocks, keep your eye on the Feds fund rate as well. Stocks tend to react to any change in the rate, and a lower rate may mean the market will increase as companies can borrow money for less, making their stocks more valuable.  

Should I hold off on saving money with low interest rates? 

Even with low interest rates, saving money is a good idea. However, it pays to educate yourself on economic conditions. If you believe the economic downturn, with its lower interest rates, will be a short-term glitch in a growing economy, you can always wait a few months to see what the FOMC does at its next meeting. If, on the other hand, it appears that the economy is moving toward a recession or low-growth period, waiting a few months may not make a difference. 

If that’s the case, you may want to prioritize paying down debt first, before you begin a program of savings, since you are probably paying more in credit card debt and loan interest than you would be earning via a CD or other investment. For some debts, such as many mortgages, anything you apply to the debt beyond the fixed payment will go toward the principal, saving you future interest payments and reducing the length of your loan. This is also a good time to consider a refinance of your mortgage or student loans, depending on what you’re paying in interest. 

If your credit card debt is high, you may want to consider taking out a debt consolidation loan to pay off all your credit cards. With the Fed Funds rate low, you can probably get a personal loan with lower interest than the rate you’re paying on the cards. This also allows you to pay just one lump sum a month, rather than writing out checks for all your consumer debts, and it saves you money in the long term on interest rates.

One case where you don’t want to skimp on savings, even in a stagnant economy, is if you have a retirement savings plan that includes employer contributions. Regardless of the state of the economy, it makes sense for you to put the maximum in this long-term savings vehicle so that you can earn the highest employer contribution.

If you’re still thinking of opening a high-yield savings, CD or money market account during a time when the Fed funds rate is low, do shop around for the best rates, and consider investing in longer-term CDs — such as five years or more — if you can afford it, since it will earn slightly higher rates of interest. But pay attention to the fine print: upfront fees or early termination fees could erase your interest earnings quickly.   

Mary Van Keuren

Personal Finance Contributor

Mary Van Keuren has been covering auto and home insurance for nearly five years, and has published numerous reviews of state-specific insurance trends and how to find the best insurance deals for your money. She earned B.S. and M.A. degrees from Nazareth College in Rochester, N.Y. and has been writing professionally, both in print and online, for 30+ years.