Banks Drop Prime Rate to 11%, Bringing Relief to Loan Holders

The nation’s banks Monday dropped their prime lending rate--the benchmark for many consumer and small-business loans--to 11% from 11.5%, convinced that the weakness in the economy is bringing a general easing of credit.

The move, which reversed a yearlong upward drift in the prime, was kicked off by Citibank, followed by Morgan Guaranty Bank, Chase Manhattan Bank, Bank of America, Wells Fargo Bank and others. The banks’ action was based partly on expectations that the Federal Reserve Board will soon ease credit further by dropping a key rate it controls, the so-called federal funds rate, economists said.

Combined with the drop in other rates since March, the cut in the prime will bring a measure of relief to consumers who have been squeezed since early 1988 by hikes in their adjustable-rate mortgages, home-equity loans and other variable-rate borrowings. Some economists foresee a continued easing of credit that will provide more comfort for these borrowers and will help stimulate a housing market that has stalled in some parts of the country.

“For borrowers who last winter feared floating rates would keep going up, this is good news,” said David Jones, an economist with Aubrey G. Lanston & Co., a major government securities dealer in New York.

The Federal Reserve had been raising interest rates for about a year in an effort to slow down the economy and squeeze out the inflation that seemed to be building. But signs of an economic weakening have been accumulating in recent weeks, including reports showing a slowdown in housing starts and auto sales.

The evidence strengthened last Friday, when a government employment report showed that job growth in May was about 100,000 jobs, half as large as expected. The report set off wide speculation that the Fed would begin lowering the federal funds rate--the rate on overnight loans among banks--after a year of increases that has raised it to 9.75%.

On Friday, the medium-sized Southwest Bank of St. Louis announced that it would lower its prime to 11%, but no major banks followed suit until Monday.

Some maintain that the likelihood of a big lowering of rates by the Fed has been overstated. Even some of those inside the Fed who favor lower rates contend that any move is likely to be small.

“There are several signs pointing to a modest easing, but nothing that warrants all this attention,” said one official, who agreed to speak only on condition that he remain unidentified.

Among the interest rates that have already declined are those on standard, 30-year fixed mortgages, which have been easing since peaking in mid-March at about 11.2%. These mortgages are available for 10.25% in some places--representing a healthy 10% drop in three months, said David Rolley, economist with the Drexel Burnham Lambert investment bank.

“When your mortgage cost drops 10%, that’s a big deal,” he said.

Many holders of home-equity loans will quickly be seeing a reduction in their monthly obligations, because many such loans are tied to the prime and are repriced each month based on the prime’s movements.

“These are still up sharply from a year ago, but a lot of people were expecting the next step in the prime would be to 12%, rather than 11%,” said Paul Getman, director of financial services at WEFA Group, an economics consulting firm in Bala-Cynwyd, Pa.

A homeowner with a $10,000, 10-year home-equity loan would be paying $137 a month at an interest rate of 11%, said Getman. Last year, when the prime was at 9%, the homeowner paid $127.

The prime’s drop may quickly help stimulate more home building, according to Drexel’s Rolley, because loans to many construction companies are tied to it. “There’s been a lot of gloom and doom written about this part of the housing market, but they’re going to breathe a little easier because of this,” he said.

The general decline in interest rates has had less effect on the market for adjustable-rate home mortgages. That market has become tougher in recent weeks as lenders have withdrawn low “teaser” rates that had been offered at 4% to 5% below prevailing rates. After years of bruising competition, lenders decided that they had lost too much money and began pulling back.

Still, some analysts believe that the real estate market has already been stirred by the decline in rates and that the situation may be more attractive to buyers by the end of the year.

“We seem to have seen some signs of new life in markets like Washington that had been dead in the water,” said John Tuccillo, chief economist at the National Assn. of Realtors. He said the decline in the prime “has a psychological effect--it makes people less fearful of what might happen next.”

Ken Ackbarali, senior economist at First Interstate Bank in Los Angeles, forecasts a continued fall in the prime that will bring the rate down to 9.75% by the end of the year. “At that level, many more home buyers can qualify for a mortgage, even in areas where the prices are above average,” he said.

Times staff writer Tom Redburn in Washington contributed to this story.

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