3 Ways the Federal Reserve's Interest Rate Decisions Could Impact Your Wallet This Year

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The Federal Reserve started raising interest rates two years ago to combat rising inflation and has mostly been successful at cooling it down. The slowdown in inflation has caused the Fed to consider cutting interest rates several times later this year.

With these potential cuts on the horizon, many Americans are likely wondering what it could mean for their budgets when the cuts come. Here's what interest rate cuts could mean for credit cards, auto loans, and mortgage rates.

1. Credit card APRs could come down

Americans are grappling with historically high credit card interest rates, with the average consumer paying a 24.6% annual percentage rate (APR). Unfortunately, many Americans have had to rely on their credit cards over the past couple of years as inflation drove prices higher, resulting in a record $1.13 trillion in credit card debt.

The good news is that if the Fed cuts interest rates, credit card APRs will likely fall. Credit cards typically have variable interest rates based on the market, so a rate cut could quickly help lower APRs.

The bad news is that because credit card interest rates are already so high, any pullback on rates may not offer enough relief to consumers. If you're having a difficult time paying down your credit card balance, consider talking with a debt counselor or using a debt consolidation loan to combine your debts into one lower-interest fixed payment.

2. Auto loan rates could drop

Federal Reserve rate cuts won't impact current car loans if you have one. Unlike credit cards, auto loan rates are fixed. So if you used a loan to buy a car recently, your interest rate on the loan will continue to be the same no matter what the Fed decides to do.

But if the Fed does cut rates this year, car loans that begin after the cuts could likely be lower than current rates. New car loans have interest rates of about 7.1% right now, so if you can wait for the rate cuts to buy a vehicle, it could be good for your finances.

Consider that a five-year car loan for $40,000 at 7.1% has monthly payments of about $794. But if that rate eventually drops to 6.1%, you'll pay about $776 monthly.

3. Mortgage rates could slide lower

Many Americans (including me) are sitting on the sidelines of the housing market because of rising house prices and interest rates over the past couple of years.​ This combination has made housing more unaffordable than it has been in nearly 40 years.

If the Federal Reserve decides to cut rates, mortgage interest rates could also come down. That could open up more buying power for potential home buyers looking for financial relief in the housing market.

To help give you an idea of how much interest rates affect mortgage payments, let's assume you want to buy a $350,000 house and are taking out a 30-year loan with a 7% interest rate and a 20% down payment. In this scenario, your monthly mortgage payment -- principal and interest -- would be $1,862. But if your interest rate were 6.5%, your monthly payment would be $1,771 -- $91 cheaper!

It's worth noting that other factors affect mortgage rates besides the federal funds rate. For example, the Wall Street Journal recently reported that demand for mortgage-backed securities isn't as high as it once was.

Without going too deep into this market, mortgages are often packaged together and sold to investors on a secondary market. When they're in demand, this can help bring rates down. But when they're not in demand, rates don't fall as easily.

With the appetite for mortgage-backed securities lower right now, mortgage interest rates could remain higher for longer even if the Fed cuts rates.

One way to help your finances no matter what the Fed does

You can't control what the Federal Reserve does with interest rates, but you can improve your chances of getting a loan or a lower interest rate by improving your credit score. Lenders often give the best rates to borrowers they deem creditworthy, so here are a few ways to boost your score.

• Pay your bills on time. Your payment history accounts for 35% of your FICO® Score. Making payments on time and for the total amount due helps lenders trust that you'll pay them back on time for a new loan or line of credit.
• Reduce your balances. The amount of money you owe lenders is the second most important factor in your score, accounting for 30%. Try to pay off your smallest balance to reduce the amount you're borrowing. This will help you lower the amount of money you owe relative to your available credit, called your credit utilization.
• Keep accounts open and active. Even if you pay off a credit card, keeping the account open may be a good idea. The length of your credit history accounts for 15% of your credit score, so don't close accounts you've had open for a long time.

No one knows what the Federal Reserve will do with interest rates this year, but improving your credit score now could be the best way to take control of your finances. If you boost your score now and the Fed cuts rates later, you'll be in an even better position than if you didn't make these moves.

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