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What Happens to Interest Rates During a Recession?

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As many states begin reopening following coronavirus lockdowns, millions of Americans and businesses are slowly attempting to regain their footing amid vastly different financial circumstances. Which leaves many of us wondering: what’s next? 

With a recession underway how will costs be affected? What about home or car prices and their respective loan rates – is now the right time to buy, or is it better to wait it out? The answer depends, in part, on interest rates, which are fees that borrowers pay to a lender, calculated as a percentage of the principal amount.

Common examples of interest rates are the annual percentage rate on your credit cards, mortgages and car loans. Banks may also pay you to keep your money with them, as is the case with many savings accounts and certificates of deposit – this type of interest is called an annual percentage yield. 

What’s happening with the economy can influence whether the rates on your debts and certain accounts go up or down. We’ll explain how that works and how that could impact your financial plans, ahead. 

But first, what is a recession anyway?

Economists define a recession as a period of significant economic decline that lasts more than a few months. A few key characteristics of a recession include a hike in unemployment, as well as a drop in real gross domestic product, income, retail sales, and manufacturing.

Although the stock market can slump during a recession, too, it’s not a factor that’s taken into account to assess if an economic downturn is looming. Many analysts will try to forecast recessions, but it’s up to the National Bureau of Economic Research, a nonprofit organization that tracks recessions, to make the official call as to whether we’re in one.

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Why do interest rates shift during a recession?

When the economy dips, companies may shutter or curb business, and unemployment typically goes up as workers lose jobs. In general, many people tend to hold off on spending and borrowing during a recession – if you’re out of work, you’re probably not thinking about buying a home or car.

In response to sluggish economic activity, central banks, like the US Federal Reserve (aka the “Fed”), may step in and try to stimulate some spending by cutting interest rates.

This essentially means that rates on things including certain mortgages, car and personal loans, and credit cards could drop, so if you were considering taking out a loan or even refinancing your home, you could get a better rate now, and potentially end up with smaller payments. 

Something to keep in mind: though interest rates tend to fall during a recession, banks may have stricter credit requirements, so it could be tough for some borrowers to qualify for the best rates. 

Who sets interest rates?

That job is primarily left to the US Federal Reserve (aka the "Fed”), which controls the federal funds rate (the “fed rate”). Generally, the fed rate is the interest rate at which banks and other depository institutions lend money to each other.

There’s a lot of complexity here, but generally, whenever the Fed changes its rate, it can impact all of us. For instance, at Marcus, we consider any changes to the fed funds rate when determining the rates we offer customers.

How interest rate changes impact your money

When the Fed adjusts its rates to minimize economic and market disruption, here’s where you might feel it: 

Savings products – moves with rate cuts

Rates on savings vehicles like money market accounts, savings accounts and CDs will usually follow the fed rate. So, when the Fed lowers its rates, you’ll likely see a cut to the APYs (Annual Percentage Yields) offered on some deposit accounts. However, don’t let a dip in APY discourage you. It’s still a good idea to keep working toward your savings goals. 

Credit cards – moves with rate cuts

Credit card APRs may also go down, and is one of the few changes you might notice shortly after a Fed rate cut. If you’re able to pay off your credit card balance every month the drop may not matter, and the small rate reduction of 1.0% to 1.5% won’t be a big game changer for those who continue to pay only minimum payments on credit card debt, either.

Personal and auto loans – depends on your borrowing terms

Personal or auto loans with a fixed rate won’t be impacted by the Fed’s activity, so your monthly payments will likely stay the same. 

However, some auto and personal loans with a variable interest rate may track, or move with the Fed’s rate decisions. This means you may be able to get a better deal on a personal loan or car loan during a recession.

Mortgage rates – depends on your mortgage type

If you have an adjustable-rate mortgage or home equity line of credit (HELOC), then you may see some reduction in your payments as rates may drop along with the Fed’s cuts. 

Homeowners with a fixed-rate mortgage could consider refinancing to a lower rate, which could offer substantial monthly payment savings, or a significant reduction in your loan term. 

Remember that any refinance will also include closing costs, so you’ll have to determine whether it’s worth refinancing and how long it will take to recoup these costs. 

3 steps to feel more secure in your finances

Worried about the impact of a recession on interest rates and your money? Here’s how you can prepare for any shifts: 

1. Make your savings work harder for you

While interest rates on savings accounts may be dropping, it’s worth doing some comparison shopping between providers to see who offers the best rate. Many online platforms offer high-yield savings accounts that can give you a better rate compared to a traditional savings account. 

For example, according the FDIC, for the week of June 1, 2020 the average interest offered on savings accounts was 0.06%. And while the difference between 0.06% and 1.0% might not seem that great, even seemingly small differences in APYs can add up to big savings over time.

See for yourself by playing around with our savings interest calculator.

2. Try to reduce debt

If you’re able to, chip away at high-interest debt or pay it off completely. Doing so can give you more breathing room in your budget and the ability to put away more into savings.

Paying down debt (and on time) can also boost your credit score, which could help you qualify for the better borrowing terms later on.

3. Refinance if it makes sense to do so

Homeowners with a good credit score may consider refinancing your mortgage – a lower rate can help you save on monthly mortgage payments. Just be sure to consider closing costs and other expenses before you commit.

Remember, recessions don’t last forever

As stressful as recessions may sound, historically, the economy has bounced back from them. And while interest rate cuts may not be favorable for some savings accounts, they could curb interest rates on debt, like auto loans and certain mortgages, potentially reducing your monthly payments.

By understanding how recessions work and how they affect interest rates, loans and savings vehicles, you can prepare for and take advantage of savings and spending opportunities, so you'll be better equipped for the next period of growth.

This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this site were commissioned and approved by Marcus by Goldman Sachs®, but may not reflect the institutional opinions of The Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.