Q & A : Rate Hike’s Mixed Effect : Tips for Consumers, Borrowers, Savers and Investors

The Federal Reserve Board’s move Tuesday to raise short-term interest rates by half a percentage point will have a mixed effect on consumers, borrowers, savers and investors. Some borrowing rates, including those on many personal loans, will rise. But other rates, including those on fixed-rate mortgages, could fall.

Here are some answers to key questions about the Fed’s move.

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Q: How will the rate hike affect my loans?

A: It depends on what kind of debt you have. If you have an adjustable-rate credit card or a home-equity loan that’s linked to the prime rate, your rate will probably go up immediately because most banks followed the Fed’s lead Tuesday and raised their prime rates by half a point. Rates on most adjustable-rate mortgages will also rise, but more slowly.

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Q: Will the Fed’s action push up rates on fixed mortgage loans?

A: Ironically, Tuesday’s increase in the discount rate should keep rates on fixed mortgages stable or even push them lower. Yields on 10- and 30-year Treasury bonds, which bankers use to price their fixed-rate mortgages, fell after the Fed’s announcement because bond investors had renewed confidence that inflation will remain under control. Some lenders and mortgage brokers subsequently reduced the rate on their fixed-rate loans by as much as a quarter of a point.

Others dropped their up-front charges. Los Angeles-based First Interstate Bank knocked 0.375 point off its loan set-up fees, which trimmed $562 off the cost of a new, $150,000 mortgage, according to Mortgage Market Weekly, a Santa Ana-based firm that follows mortgage trends.

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Q: What about adjustable-rate mortgages?

A: Unfortunately, most lenders raised their ARM rates by as much as half a point Tuesday because adjustable-rate mortgages are pegged to the prime rate, short-term Treasuries or other vehicles that tend to move in lock step with increases in the Fed’s discount rate, which rose to 4% from 3.5%.

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Q: I’ve been thinking about buying a home. What should I do now?

A: Don’t be in a rush to close a deal. Most experts say fixed mortgage rates will remain flat for the rest of the year, and a growing number now say they could drop as much as a quarter of a point more. That would knock about $27 off the monthly cost of a $150,000 loan.

If home prices were rising sharply, it wouldn’t be worth waiting for a modest decline in rates, because your savings in interest costs would be wiped out by the higher price you’d pay for your home. But because home prices in Southern California are flat and the spring home-buying surge is over, “there isn’t much of a chance that prices in the region are going to go up much over the next several months,” said David Berson, chief economist of the Federal National Mortgage Assn. (Fannie Mae) in Washington.

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Q: Will the rate that banks pay on certificates of deposit also rise?

A: They may, but probably not enough to match the Fed’s half-point increase in the discount rate. With many consumers and businesses nervous about borrowing money, most banks are already awash with cash and have no reason to raise their deposit rates to attract more money.

“Rates on CDs might go up a little bit, but not a full half-point,” said Paul Havemann, who tracks interest rates for the consulting firm HSH Associates in Butler, N.J.

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Q: Is there anything I can do now to protect my pocketbook in the months ahead?

A: Yes. With interest rates rising, you need to become a more aggressive consumer. For example:

* If your bank raises your credit card rate, call and complain or look for a different company. “Competition in the industry is fierce, and many vendors will lower their rate or waive their annual fees just to keep your business,” said Havemann at HSH Associates.

* If you invest in CDs, contact at least six institutions to shop for the best rate, or consider using a broker to find the best deal. The Times’ Business section publishes a list of the highest-paying CDs every Sunday and Monday.

* Although rates on ARMs are rising, don’t automatically rule them out if you’re buying a home or refinancing. If you plan to move again within three years or so, an ARM with a low initial rate is still going to be your best choice because you’ll save money in the first couple of years and will sell before the rate has a chance to ratchet skyward.

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Q: How will the rate increase affect the stock market?

A: If the hike slows the economy and prolongs the recovery--as most analysts expect--the outlook for stocks and bonds should be bright. The wild card is that many investors may now turn to more conservative investments, such as Treasury bills, to eliminate their risk but lock in a guaranteed return. With one-year Treasuries now paying a healthy 5.5%, it’s hard to blame risk-averse investors if they shun the uncertainty of buying stocks or bonds.

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Q: How will the rate hike affect the economy?

A: It should slow the economy down. When banks’ borrowing costs go up, they pass along the increase to their customers by charging higher rates on everything from credit cards to business loans. People borrow less and spend less when interest rates are high, which in turn puts a damper on economic growth.

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Q: Then won’t raising interest rates make inflation worse, not better?

A: In the short-term, the rate hike could make inflation worse. But the Fed’s job is to worry about inflation down the road, not what inflation is doing today. If the Fed’s strategy works and the economy slows, it will ease long-term inflationary pressures and prevent interest rates from skyrocketing next year and beyond.

Up, Up and Away

The Federal Reserve’s move Tuesday to push short-term interest rates a half percentage point higher will raise borrowing costs for millions of Americans. The Fed raised, to 4.75%, the federal funds rate, which banks charge each other for overnight loans. The Fed also hiked, to 4%, the discount rate that it charges on its own loans.

Most major banks immediately followed by raising their prime rates to 7.75% from 7.25%. Rates on home equity loans, credit cards and personal loans will also jump, as they are generally tied to the prime rate.

However, savings rates are expected to continue rising far less dramatically than loan rates. That’s because demand for loans isn’t sufficient to spur heady competition between banks for deposits, many experts say.

Mortgage rates may not necessarily rise, because they are linked to long-term interest rates, which actually fell Tuesday because the Fed’s move was seen as a strong attack on future inflation. Inflation expectations are the main force driving long-term interest rates.

FEDERAL FUNDS RATE Aug. 16: 4.75%

SIX-MONTH CD AVERAGE VS. THE PRIME RATE 2nd week, August Prime rate: 7.75% Six-month CD: 3.49% (Through Aug. 16)

30-YEAR, FIXED MORTGAGE RATES Southern California averages, weekly figures: 2nd week, August: 8.537% (As of Aug. 11)

Sources: Tradeline; Mortgage News Co.; Associated Press; Bradshaw Financial Network