How to prepare for an interest rate cut (and 4 money moves you should avoid)

After raising interest rates to their highest point in 23 years, the Federal Reserve, America’s central bank, is gearing up for a cut to its benchmark interest rate next month — the first since March 2020. When rates change, their effects don’t just ripple through the economy, but they also impact our personal finances in both subtle and obvious ways.

Lower interest rates decrease costs for borrowers, making it more affordable for you to take out a car or a home loan. However, lower rates also decrease how much interest you can earn on savings and other deposit accounts, reducing their contribution to passive income.

As someone who’s navigated various interest rate environments, I know that preparedness makes a world of difference. From locking in high rates using certificates of deposit (CDs) to refinancing a loan or timing a large purchase, here are the smart money moves you can take today — before rates are expected to drop next month.

3 proactive steps to take before an interest rate cut

There are several strategic moves you can make with your money and finances to better position yourself for the next interest rate cut.

1. Boost your interest income with a high-yield savings account

While the Fed is likely to cut interest rates soon, there’s still time to maximize the passive income you earn by opening a high-yield savings account.

For example, after comparing traditional and high-yield savings, I realized I was earning an annual percentage yield (APY) of 0.01% on my everyday savings account. At the same time, some high-yield savings accounts were paying out 5.00% APY or more.

Here’s an idea of the earnings potential I’d miss out on with my traditional account versus an HYSA on a $10,000 deposit:

The best part is that the money I earn on my initial deposits also earns interest, adding a compounding effect that translates to a lot more money in my pocket over time. And since it’s all in a savings account, I can easily access my funds when I need them.

Keep in mind that while the Federal Reserve might cut rates by a quarter or a half point, you should still be able to find HYSAs offering more than 4.00% APY into the fall.

2. Lock in higher rates on long-term CDs

While high-yield savings accounts are a useful savings tool, they come with variable interest rates that can change with the market — and drop with interest rate cuts from the Fed. That’s where CDs come in: Certificates of deposit allow you to lock in a fixed APY today that stays the same over the entire term of your CD.

For example, opening a 15-month CD that earns 5.00% today means you’ll continue earning 5.00% on this CD’s funds through next summer and over the entire 15 months, even after interest rates drop. That’s a guaranteed return of about $629 on a $10,000 deposit, not accounting for compounding. 

However, keep in mind that you should only use cash that you won’t need for a while. Most CDs impose penalties on early withdrawals, which would diminish your returns. Luckily, you can divide your money among several CDs of varying terms, for example, from 6 to 36 months, to gain access to portions of your money over time, a strategy known as a CD ladder.

Dig deeper: How CDs work — including 7 types that can boost your savings

3. Review your investment assets

As we approach the first Fed rate cut next month, it’s a good idea to look at your investment and retirement portfolios to review your asset allocation.

The stock market typically benefits from lower interest rates, while bonds often yield smaller returns when interest rates are low. That’s why I spoke with my financial advisor and called my retirement portfolio manager to discuss moving some of my bond allocation over to stocks in anticipation of weaker rates. 

Just make sure that any changes you make fit your risk tolerance and plan for retirement. Don’t be afraid to speak with a trusted financial advisor who specializes in retirement. And keep in mind that investment performance is far from guaranteed, so lower interest rates don’t promise improved stock returns.

Dig deeper: How to find a trusted retirement advisor for peace of mind in your golden years

3 smart strategies to rely on after an interest rate cut

You’ll have a fresh set of opportunities to use after the Fed cuts interest rates. Here are some of my favorite money moves to make when rates go down.

1. Refinance your existing high-interest debt

When rates start to slide, it’s the perfect time to rethink your existing debt because you might be able to replace an existing loan with a new one, ideally with a lower interest rate or more favorable terms. This is known as loan refinancing options.

Like many Americans, I have loans that I’d rather pay over time. This includes my five-year car loan, which currently sets at a balance of $25,000 and an annual percentage rate (APR) of 6.00%. Even a small rate drop of 0.50% can save me over $300.

While car loans can be worth refinancing, especially with bigger rate changes, other loans like mortgages often benefit more from refinancing due to their larger balances and longer terms. 

But remember that refinancing your loan may come with its own costs. For example, refinancing your mortgage typically costs you an origination fee for the new loan along with various smaller fees and charges to cover the appraisal and paperwork needed.

The average mortgage refinancing costs $5,000, according to the Federal Home Loan Mortgage Corporation. So make sure to factor in any fees you may incur while moving your loan to new terms or a new financial institution.

2. Make strategic large purchases

From a new fridge to an upgraded garage, many large purchases can strain your finances, especially if you plan to pay for them over time. But if you plan to borrow to cover a high-price cost, you'll pay less interest on your loan after rates come down.

Depending on where you shop, you could even qualify for a promotional 0% APR on your large purchase, which would eliminate your borrowing costs altogether. Car dealerships and appliance retailers are among businesses that typically offer 0% APR financing terms during periods of lower interest.

That’s why I’ve put off my planned kitchen upgrade until the next interest rate cut (and judging by the condition of my cabinets, I’d say it needs to be soon!). But overall, timing big-ticket items like home renovations or updates with interest-rate cycles can significantly lower your overall costs. And in the meantime, you can shop around, collect ideas, get quotes — and even sock away money in high-yield savings while you wait.

3. Consider taking out a new loan

When the Federal Reserve cuts interest rates, it lowers how much it costs to borrow across the U.S. Whether you’re considering a debt consolidation loan — a type of loan that combines multiple debts into one new, lower-rate loan — or a mortgage for your dream home, waiting until a rate cut to get a new loan will result in more manageable monthly payments.

That said, you shouldn’t take out a loan simply because it’s more economical. Instead, think about whether a new loan can serve your long-term financial goals. For example, a debt consolidation loan should help you pay off your debts faster and save you enough money on interest to justify the loan. Similarly, a home mortgage should align with your income, needs and overall financial plan.

If you do decide to take out a loan after the Fed cuts interest rates, make sure to shop around and carefully read and understand each loan's terms and fine print. I’ve found that credit unions often offer competitive rates, so I typically start by comparing their offers to traditional banks and online lenders.

Dig deeper: What is a personal loan? How it works — and what to know before you apply

4 money moves to avoid when the Fed cuts rates

Interest rates are a double-edged sword, whether they’re high or low. When they’re high, they make it easier to earn passive interest income, while low interest rates make it cheaper to borrow. Make sure to avoid these common pitfalls after the Fed cuts its rates:

Dig deeper: When’s the next Federal Reserve meeting? The FOMC — and how it affects your finances

FAQ: Fed rate cuts and your finances

Should I buy bonds when the Fed cuts interest rates?

Buying bonds after an interest rate cut isn’t a good idea, as the yields of newly issued bonds decrease along with the Federal Reserve's benchmark rate. On the other hand, buying bonds before an interest rate cut is a smart money move as it allows you to lock in high yields before they decrease. Overall, bonds can provide safer returns on your invested money when compared to stocks, allowing them to play an important rule in your financial wellness. 

How does the Fed rate affect mortgage rates?

The Fed rate influences mortgage rates indirectly. When the Fed adjusts its federal fund rate, it impacts banks’ borrowing costs. This change ripples through the bond market, affecting bond yields. Since mortgage rates are typically tied to such bond yields as the 10-year Treasury yield, they tend to move in the same direction as Fed rate changes. However, this correlation isn’t perfect or immediate, as inflation, housing demand and other factors play into lender mortgage rates.

What’s the difference between the federal fund rate and interest rates?

The federal fund rate is a specific type of interest rate. It’s a benchmark rate defined by the Federal Reserve that specifies the interest banks charge each other for overnight loans to maintain their required reserves. By making changes to this rate, the Federal Reserve is able to have broad influence on the economy. Interest rates is a general term that typically refers to the cost of borrowing money or the potential earnings on deposit accounts, like savings accounts or CDs.

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About the writer

Yahia Barakah is a personal finance writer at AOL with over a decade of experience in finance and investing. As a certified educator in personal finance (CEPF), he combines his economics expertise with a passion for financial literacy to simplify complex retirement, banking and credit topics. He loves empowering people to make informed financial decisions that improve their everyday and long-term wellness. Yahia's expertise has been featured on FinanceBuzz, FX Empire and EarnForex. Based in Florida, he balances his love for finance with freediving, hiking and underwater photography.

Editorial disclaimer: Information on this page is for educational purposes and not investment advice or a recommendation to buy any specific asset or adopt any particular investment strategy. Independently research products and strategies before making any investment decision.

Article edited by Kelly Suzan Waggoner