Fed cut eases debt but hurts savings

The low interest rate regime of the Federal Reserve presents consumers with both an opportunity and a challenge.

The opportunity comes mainly on the debt side of the balance sheet. Refinancing just about anything, from a home mortgage to a car loan or credit card debt, can get a consumer a reduced interest rate. That means lower monthly payments and less paid in interest over the life of a loan.

The challenge is on the savings side. Interest paid on savings accounts -- whether at banks or in money market mutual funds -- is at 40-year lows, and could fall farther following the Fed's decision last week to cut rates another quarter of a point.

People who rely on the earnings from their savings, particularly the elderly, are struggling to cover day-to-day expenses. And young couples are being forced to save more if they hope to accumulate enough to cover a child's education or their own retirement.

Experts offer a variety a strategies for coping in a low-rate environment:

Pay down debt

With the national average interest rate on a standard credit card at 13.43 percent, a consumer can save a bundle by paying down an outstanding balance, said Greg McBride, senior financial analyst at Bankrate.com.

If consumers can't pay down their balances, "they definitely should call their credit card company and ask for a lower rate or consider switching to a lower-rate card," he added.

A family with $8,000 in credit card debt could save $552 a year by switching from a card with 13.43 percent interest to one with 6.9 percent, he calculated.

"With a lower rate, the process of repayment is accelerated," McBride pointed out. "It's like having the wind at your back."

Refinance

Millions of Americans already have taken advantage of low interest rates to refinance their mortgages. Some are even doing it a second or third time -- and they're also refinancing car loans and student loans.

"If you are financing a long-term asset, these are the lowest finance costs in two generations," said Douglas G. Duncan, chief economist for the Mortgage Bankers Association of America.

Refinancing has a number of benefits. It not only lowers interest costs over the life of a loan, it also frees up cash in a family's budget for other uses.

Hunt for best savings rates

Interest rates are averaging 0.76 percent on checking accounts and 1.20 percent on savings accounts, and could go even lower after the Fed's latest action. So savers need to strategize to try to earn more.

Bankrate.com's McBride suggests that "laddering" savings accounts can help.

"It involves diversifying your cash investments among a range of maturity dates," he said.

Start by investing in CDs with maturities of 3 months, 6 months, 9 months and a year, McBride said. There are 12-month CDs out there paying 2.25 percent.

"You keep rolling them in the same maturities as long as interest rates remain in the doldrums," he said. "When rates start improving, you can go to longer maturities like two years, three years, four years and five years."

Look again at stocks

A lot of families pulled their money out of the stock market and out of equity mutual funds during the three-year bear market. But stocks traditionally have yielded the best return over time -- nearly 7 percent after inflation, and blue chips have begun recovering and are up 10 percent so far this year.

"This is a good environment for investing in the stock market," said Harold Zeitz, chief operating officer at ShareBuilder Securities of Bellevue, Wash. "The tax cuts are putting more money in peoples' pockets, and the Fed's interest rate cut is positive for the markets."

Tread carefully with bonds

Brent Brodeski, managing director of the fee-only financial planning firm Savant Capital Management Inc. in Rockford, Ill., said savers should focus on their stock allocations before they look at bonds.

"The key for the small investor is to maximize their 401(k) retirement account," he said. He noted that the tax break on contributions -- plus the matching money from most employers -- "makes these high-octane accounts."

Those who want a bond component in their 401(k)s should consider stable-value funds, he said. These funds -- which combine bonds and some bank or insurance instruments -- currently are paying 3 percent to 5 percent. While they provide reasonable returns when rates are low, they tend to be slower than other investments to rise when rates go up, Brodeski said.

For consumers who want to own bonds, Brodeski suggests "a four-legged approach" for stability. He suggests a combination of Treasury Inflation-Protected Securities to counter inflation; intermediate bonds to counter declining rates or deflation; ultra-short bonds, which are higher-yielding than a lot of cash alternatives; and foreign bonds for diversification.