Q & A : Rate Cuts Will Benefit Many--Except Savers
In a one-two punch that’s likely to provide a boost to investors, homeowners and people in debt, while delivering a blow to savers, many big banks--including San Francisco-based Bank of America and Wells Fargo and New York’s Citicorp--moved quickly to cut the prime lending rate Wednesday, in response to the Federal Reserve Board’s move to cut two key interest rates.
A series of other interest rates fell in line, which could have the long-term effect of saving consumers hundreds of dollars in interest charges while triggering another boom in home refinancing.
Here’s a look at what happened Wednesday and what it means.
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Q: What interest rates were cut?
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A: The Federal Reserve Board voted to cut two key lending rates--the discount rate and the so-called federal funds rate--by a quarter of a percentage point. These rates determine how much it costs banks to borrow money from the Fed and from each other.
Many banks immediately moved to pass those cost savings on to consumers by lowering their prime rates, which control rates on everything from home equity loans to credit cards. More banks are expected to cut their prime later in the week.
In addition, the Fed move sparked a rally in the bond market that drove down yields on Treasury bills, notes and bonds. These yields are often used to set mortgage rates, which are already approaching historic lows, says Keith Gumbinger, an analyst at HSH Associates, a rate-tracking firm in Butler, N.J.
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Q: How does that affect savings account rates?
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A: There is no direct link from the federal funds or discount rates to rates paid on deposits. But deposit rates do tend to follow these key lending rates for a simple reason: Banks need money, but it doesn’t much matter whether they borrow it from the Fed, other banks or from you. And when borrowing from the Fed is cheap, banks naturally don’t pay as much to borrow from consumers, so deposit rates tend to fall.
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Q: What about lending rates? Which of my loans are likely to be affected by a cut in prime?
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A: The prime rate affects interest rates on a wide range of loans, from car, boat and personal loans to home equity lines of credit. It also determines interest charges for many variable-rate credit card loans. The cost savings from Wednesday’s moves will not be immediate because many of these loans are fixed-rate or change infrequently.
For instance, car and boat loans are usually fixed-rate. While new borrowers would benefit from today’s lower rates, people who have outstanding car and boat loans will get no benefit.
Meanwhile, rates on home equity loans and credit cards tend to reprice just once a month, once a quarter or in less frequent intervals, such as every six months or year. Unless your bank lowers its prime rate before this adjustment period, you get stuck with the higher rate until the following adjustment period.
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Q: Are home loan rates also tied to prime?
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A: Generally, no. The rates on most fixed-rate loans and one-year adjustable loans are linked to yields paid on Treasury bills and bonds. However, the Treasury yields inched downward Wednesday as well, leaving mortgage rates at their lowest levels in several years, Gumbinger says. The average cost of a 30-year, fixed-rate mortgage today is 7.3%. That’s down from 9.15% in February 1995 and is within a hairbreadth of historic lows.
One-year adjustable loans that are tied to the Treasury bill index were at 5.51%, compared with 6.76% a year ago.
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Q: I have an adjustable-rate loan that’s tied to the so-called 11th District cost of funds index. Is that going to drop?
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A: Coincidentally, the COFI for December was announced Wednesday and fell for the first time in two months. The index is a laggard. When interest rates rise, it rises much more gradually than all others. Conversely, when they fall, it falls painfully slowly. Indeed, over the last year, while other mortgage rates were dropping, the COFI has been inching upward. It now stands at 5.059%, compared with 4.925% at this time a year ago.
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Q: Should I refinance my mortgage to take advantage of these lower rates?
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A: The answer depends on how long you plan to stay in the home and how much lower today’s rates are than the rate on your loan.
If you have a 9.15% $100,000 loan, for example, your monthly payment would be $815.44 per month. If you refinanced at today’s average rate of 7.3%, your payment would drop to $685.57, a savings of about $129 per month, or $1,558 per year. If the cost of refinancing--points and fees--is less than that and you’ll stay in the same house for at least a year, it makes sense to refinance. However, if your savings are less or you don’t plan to keep your current home for any length of time, the upfront costs of refinancing could be more than your monthly savings.
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Q: I noticed that stock prices were up again and I’d heard that it was partly due to the interest rate cuts. Why would stock prices be helped by lower interest rates?
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A: They’re helped on several fronts. First, lower rates make it cheaper for companies to borrow to finance their growth. Second, lower rates presumably spur economic activity, as consumers spend the money they’ve saved on mortgage and credit card payments on new clothes and shoes. That boosts sales and profits for retailers.
Finally, it’s a matter of supply and demand. When interest rates are high, savers and investors have a lot of options of where to put their money and get a decent return. When interest rates drop, yields on deposits and bonds tend to look anemic and people turn to stocks. More money chasing the same number of stocks tends to boost prices.
* FED CUTS INTEREST RATES
Central bank acts to boost economy. A1
* HOUSING MARKET IMPACT
California real estate should benefit. D3
