Now that the Federal Reserve has trimmed short-term interest rates, don’t conclude everything is right with the world and rush out to get yourself in debt.
The action by the nation’s central bank on Sept. 29–the first cut in more than two years–means consumers can look forward to lower rates for home-equity loans, car loans, variable-rate credit cards and adjustable-rate mortgages, probably by late fall.
But fixed-rate mortgages, which depend more on the outlook for inflation than on Fed action, are not expected to drop significantly right away.
And consumers are likely to lose out at first because the rates banks pay for certificates of deposit and other savings typically go down faster and by a larger amount than rates charged for loans.
“Consumers should now lock up CDs of at least one year or more before the downturn in savings yields begins,” said Robert K. Heady, founding publisher of the Bank Rate Monitor newsletter in North Palm Beach, Fla..
“But they shouldn’t jump into car financing, or take out a new credit-card or home-equity loan account until banks have had a chance to ratchet their loan rates downward.”
The Federal Open Market Committee, the Fed’s policy-making arm, signaled its desire for lower interest rates by cutting its target for the federal-funds rate for bank overnight loans from 5.5 percent to 5.25 percent.
It was the first time the Federal Reserve has lowered rates since January 1996, and the first change since March 1997, when the Fed raised rates from 5.25 to 5.5 percent to ward off the threat of inflation.
But the cut was a disappointment to investors who were hoping for a larger reduction to stimulate a slowing economy.
By changing how much money is available to meet bank reserve requirements, the Fed can “target” the federal-funds rate. When funds are plentiful and money is relatively easy to get, the federal-funds rate falls.
“The action was taken to cushion the effects on prospective economic growth in the United States of increasing weakness in foreign economies . . . ,” the Fed said in a typically brief and jargon-filled statement.
“This move is designed to inoculate the U.S. economy from the Asian flu” and make low-cost capital available to corporate America, said Mark Vitner, economist at First Union Capital Markets.
But Vitner said the drop in rates could benefit consumers who will see a decline in the rates they pay for consumer loans. This, in turn, could boost consumer confidence, which slumped for the third straight month in September to its lowest level in nearly a year.
A rate change by the Fed is usually followed by a similar change in the prime lending rate by major banks, the rate charged to their most creditworthy customers.
In turn, changes in the prime rate affect other consumer loans. But the impact won’t be immediate.
“It’s going to take at least two months to feel the full effect of rate decreases on your wallet, especially on the borrowing side,” Heady said.
Changes in adjustable-rate mortgages, which are typically pegged to the one-year Treasury bill, will not occur until the next adjustment date, which varies with each mortgage loan.
Fixed-mortgage rates, on the other hand, tend to follow the moves of 10-year Treasury notes because most mortgage loans are either paid off or refinanced in 10 years. Already in September 30-year fixed mortgages had hit a low of 6.66 percent, the lowest since Freddie Mac, the mortgage company, started keeping records in 1971.
“The rate cut by the Fed had been expected for several weeks if not longer,” said Brian Carey, an economist with the National Mortgage Bankers Association. All but 0.05 to 0.10 percentage point of the quarter-point cut is already reflected in current fixed-mortgage rates, he said.
So this is how the latest rate cut by the Federal Reserve is likely to affect your wallet, according to Heady:
– Look for yields on certificates of deposit to decline anywhere from 0.15 to 0.20 percentage points in the next six to eight weeks. For example, if a one-year CD has been yielding 4.75, a new one will pay 4.55 percent to 4.60 percent.
– Consumer loan rates will drop more slowly, and not by as much as savings yields.
– New-car-loan rates will probably fall by only 0.10 to 0.15 percentage points, or from 8.8 percent to at best 8.65 percent on a typical loan. On a $16,000 loan over four years, the lower rate would reduce the car buyer’s total financing cost from $3,039 to $2,984, a savings of $55.
– A cardholder carrying a $3,000 balance on a variable-rate credit card would save just $7.50 in interest a year.
– A family taking out a $20,000 home-equity loan for five years would spend $88 less in total interest.
– Adjustable-rate mortgages, which are influenced by indexes such as the one-year T-bill, should also cost less because Federal Reserve rates mostly affect short-term rates. But fixed mortgage rates, which are not tied directly to the prime rate, are not expected to drop significantly right away.
