How to manage debt as the Fed rate cuts

On September 18, the Federal Reserve cut interest rates by 50 basis points, leaving many prospective homebuyers wondering if now is the time to buy a home. Two additional rate cuts are expected before the end of 2024.

The impact of these rate cuts extends beyond the housing market, potentially affecting various sectors of the economy. Economists anticipate that lower interest rates could stimulate consumer spending and business investments, potentially leading to economic growth. However, some experts caution that the effectiveness of these cuts may be limited if inflation remains a concern or if global economic uncertainties persist.

But what do these interest rate cuts signify for consumers trying to consolidate debt or cover emergency costs with a personal loan or credit card? According to four financial experts we spoke with, your game strategy should remain the same: pay down debt as rapidly as possible at the lowest interest rate you can acquire.

A national debt crisis.

Americans are experiencing a credit card debt crisis, with millennials and Generation Z at the forefront of the problem. According to Federal Reserve data on average American debt statistics, U.S. consumers owed $1.15 trillion on credit cards in the first quarter of 2024.

This staggering figure represents a significant increase from previous years, highlighting the growing financial strain on American households. Financial experts attribute this rise to various factors, including stagnant wages, increasing living costs, and the ease of access to credit. The situation is particularly concerning for younger generations, who often face additional challenges such as student loan debt and a competitive job market.

The typical credit card interest rate is more than 20%, making paying off high-interest debt especially difficult. However, carrying an outstanding balance might cost more than $1,100 each year, especially if you pay late fees.

Four financial experts provided tips for quickly recovering from debt, regardless of your financial situation. This is what they recommend:

Consolidate your debt.

"Debt management strategies vary significantly across borrower tiers, and understanding these distinctions is essential," stated James McCarthy, a founding member of the government organization Consumer Financial Protection Bureau (CFPB). In other words, your creditworthiness is largely determined by the possibilities accessible to you.

If you have ordinary credit and carry a credit card load, McCarthy recommends looking into low-interest repayment options. A debt consolidation loan is a sort of personal loan that allows you to consolidate your credit card debt at a cheaper interest rate, providing some financial relief.

It is difficult to secure a competitive rate on a debt consolidation loan if you have a low credit score, but it is not impossible. McCarthy stated, "The key lies in demonstrating financial stability."

Some lenders evaluate variables other than credit to assess timely rent and utility payments, and borrowers with regular income and a lower credit usage ratio may be eligible for cheaper rates.

This week, the average personal loan interest rate is roughly 21% if you have great credit. However, it is much greater if your credit score is in the good, fair, or low category.

The Fed's interest rate drop will result in somewhat reduced personal loan interest rates, regardless of credit score. But don't expect major dips. The decline is only 50 basis points, or 0.5%, which is little in the larger scheme of compounding interest.

Compare Personal Loan Rates.

Prioritize paying off debt (even before investing).

"If you're having trouble paying off debt, the best way out is to pay off the principal as soon as possible," said Jeremy Schneider, a personal finance educator and co-founder of Nectarine, a flat-fee financial coaching platform. "Getting out of debt is really about making a plan and staying focused."

Schneider suggests the "snowball" strategy for getting out of debt. "Sort all your debts from smallest to largest, make minimum payments on everything except the smallest, and throw all the cash you can at the smallest debt," according to him. "Once that is paid off, you have one fewer payment to make, which can be applied to the next smallest debt and down the line."

While the snowball method can be psychologically motivating, some financial advisors also recommend the "avalanche" method for those who want to minimize interest payments. This approach involves prioritizing debts with the highest interest rates first, regardless of the balance. Both strategies have their merits, and the choice often depends on an individual's financial situation and personal motivation factors.

Schneider also advised against relying on low-interest financial solutions to tackle the problem: "A consolidation loan will not save you from debt. It's just pushing peas around the plate."

Schneider proposes that people develop healthy financial habits, such as treating credit cards like debit cards and paying them off in full each month. "If you can't commit to that, don't use a credit card at all," he told me.

Seek zero-interest financing, if available.

"Many people believe credit card debt is normal, so there's no rush to pay it off," said Sophia Bera Daigle, a Certified Financial Planner and the founder of Gen Y Planning, a millennial-focused financial planning service. "But once you're in a cycle of having credit card debt, it can take a lot of time, hard work, and focus to pay it off."

If you have excellent or decent credit, Daigle recommends shifting your debt to a zero-interest balance transfer credit card and paying it off over time to avoid incurring further interest. If your firm requires a financial lifeline, you may want to consider a debt transfer business credit card with 0% intro APR.

Daigle also recommends calling the National Foundation for Credit Counseling (NFCC) to establish a debt management strategy. This non-profit connects you with trained credit counselors who can help you establish a regular monthly repayment amount. The NFCC also offers online money management courses to help you improve your financial literacy.

It's important to note that while zero-interest financing can be a valuable tool, consumers should be cautious and read the fine print. Many balance transfer offers come with fees, and the zero-interest period is typically limited. Failing to pay off the balance before this period ends can result in high interest rates being applied retroactively. Therefore, it's crucial to have a solid repayment plan in place before opting for this strategy.

Understand the real cost of high-interest loans.

Once you've paid off your credit card debt, you should develop healthy behaviors to keep out of debt.

"Interest rates make a real difference, and it's important to know what you're paying," said Mark Elliot, chief customer officer at financial services firm LendingClub. "Many consumers struggling with high-interest debt have expressed confusion surrounding credit card APRs, and credit card companies are happy to keep it that way."

Elliot, who has previously held top positions at JPMorgan Chase and Capital One, also mentioned a widespread misperception among average consumers.

"Many consumers believe that making the minimum payment is an effective way to manage their credit card debt," Elliot told me. However, he warns that paying merely the bare minimum on credit card balances might "lead to prolonged repayment periods and significantly more interest paid overtime." Instead, customers with high credit card debt should prioritize financial knowledge and sticking to a spending plan.

A final piece of advice: "Creating a repayment strategy is critical," Elliot stated. "Aim to pay more than the minimum payment to reduce the principal balance faster, and prioritize high-interest debt."