Fed cuts interest rates again — why you should refinance debt now

The coronavirus has wreaked havoc on the economy, and in an emergency response, the Federal Reserve slashed interest rates by a full percentage point—the second rate cut in two weeks and the largest in Fed history. The reduction puts the rate between 0 and .25 percent, and sets up a situation where consumers may consider whether to refinance debt to reduce their current load.

What happens when the Fed cuts rates?

The Fed cuts interest rates in an attempt to incentivize businesses to borrow money. This has the potential to stimulate investment and hiring. Lower rates can also be an attempt to qualm fears surrounding the uncertainty of a recession. Lower interest could encourage Americans to continue spending and borrowing, which helps some of the sectors hardest hit, like retail.

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What does the interest rate cut really mean for you?

Banks use the federal funds rate to set their interest rates for products like mortgages, student loans and personal loans. The prime rate, which is generally about three percentage points above the Fed rate, is reserved for their best customers. Since the Fed’s cut its rate by a full percentage point, many banks did the same, lowering their prime rate from 4.25 percent to 3.25 percent.

Is now a good time to refinance your debt?

This may be time to refinance your current debt, especially if you have a variable or high interest rate. You may be able to refinance those loans and take advantage of rates that may not be likely to go any lower.

Mortgages: Currently, the average rate for a 15-year fixed mortgage refinance is 3.27 percent and a 30-year is 4.1 percent. While the Fed rate cut does impact mortgages, long-term loan rates are more closely tied to the 10-year Treasury yield. Demand for refinancing is high and rates are rising from record lows posted about a week ago. But that doesn’t mean you shouldn’t consider it.

“We are shouting from the mountaintops to refinance your home mortgage,” said certified financial planner Michael Hennessy, founder and CEO of Harbor Crest Wealth Advisors in Ft. Lauderdale, Fla. “While interest rates are volatile and refinance volumes have surged, if you have a four percent or higher mortgage, there is no better time than now to lock in a lower rate. If you’re considering refinancing, it’s important to shop around a few of the major lenders to make sure you’re getting an attractive deal.”

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Your decision may depend on where you live, added certified financial planner David J. Haas, founder of Cereus Financial Advisors in Franklin, Lake, N.J. “You would think that this is a great time to refinance, but right now, today, I think it’s not,” he says. “I have recently been working with a client who wants to take out a second mortgage, so I have done a little research. Other states have been dropping, but New York is stubbornly high. I think there are liquidity issues in the bond market and the banks may be worried that they can't sell their mortgages. I think the Fed will do things to make the situation better and will also try to drive down long-term rates again like they did in the great recession. So, if you want lower rates, I would say wait four weeks.”

Student loans: Another debt you could consider refinancing is student loans. Currently, the government interest rate for federal student loans is 4.53 percent. However, this type of loan cannot be refinanced. If you want to refinance your federal student loans, you will need to shift your debt to a private lender, many of which have dropped their rates. Some private student loans have interest rates as low as 2.89 percent, and now may be a good time to refinance. However, you will lose the government-backed protection that federal loans offer, such as income-based repayment, deferment or loan forgiveness programs. If you think you may need one of these programs, it may be best to keep your loan as is.

Credit card debt: Another type of debt you can consider refinancing is revolving debt, such as credit cards. Card issuers tie their rates to the prime, and the Fed rate cut could lower the amount of interest you are paying. If your card charges high interest, though, it can be best to pay it off. Either transfer your balance to a 0 percent interest card, or investigate fixed-rate personal loans. Personal loan rates usually range from 6 to 30 percent, but some banks have lowered rates further. For example, Wells Fargo offers a personal loan with APR as low as 5.24 percent. Refinancing a high-interest credit card to a low fixed-rate loan could save you money in the long term.

How to know when the time is right to refinance

Don’t get caught up in the interest rate and overlook the costs that may be associated with some loans. No matter what kind of debt you want to refinance, many lenders will charge fees, such as closing costs, balance transfer fees and loan origination fees. These costs could eliminate any savings you might realize from the lower interest.

And refinancing your mortgage is not a solution if your income goes away because of coronavirus, cautioned Haas. “No bank will loan you money if you have no income,” he says. “So, it only remains a tool if you have a good stable income.”