Borrowers, Savers Will Feel Fallout
Many borrowers will be paying higher interest rates in the weeks ahead after several major banks boosted their prime rates a quarter-point Tuesday, matching the Federal Reserve’s move to raise its key short-term rate earlier in the day.
Meanwhile, the effect on long-term rates, such as for mortgages, is less certain.
On the savings side, investors in money market funds can expect to see rates continue to inch up in the next month, while bank savings accounts may take longer to rise.
The Fed raised its target for the federal funds rate by a quarter of a percentage point Tuesday, to 5.25%. The federal funds rate is what banks charge each other for overnight loans, and it’s a benchmark for lending rates in general.
(The Fed also raised its less significant discount rate by a quarter-point.)
With the fed funds rate rising, major banks including Wells Fargo, Bank of America and Bank One immediately raised their prime lending rates from 8% to 8.25%.
The prime rate determines costs for most bank and credit card loans as well as certain adjustable-rate home loans.
Credit card interest payments alone will rise by hundreds of millions of dollars over the next several months, according to CardWeb in Frederick, Md. Still, consumers who shop around can often offset a small interest rate increase, financial experts said.
And the Fed’s increase won’t flow evenly through the financial system. Here’s a look at possible Fed fallout on loan and investment rates:
* Mortgages: Experts have mixed opinions about whether fixed-rate home loans will react to the Fed’s latest move. Some believe the bond market already factored in the quarter-point increase and that Tuesday’s action could actually cause mortgage rates to fall slightly as calmed bond traders worry less about future inflation.
Because the Fed said it has a “neutral” stance toward higher rates in the future, “there’s some hope [about mortgage rates stabilizing or falling], where a month ago there wasn’t,” said Earl Peattie, president of Morro Bay, Calif.-based Mortgage News Co.
If economic data over the next few weeks suggest a slowing economy, “rates could come down,” he said.
Mortgage rates have risen for much of this year, peaking at a two-year high of 8.15% two weeks ago for a 30-year loan, according to mortgage giant Freddie Mac. That average has since slid to 7.93%.
Other trends in the Treasury bond market have helped keep fixed mortgage rates lower, because many are linked to the 10-year Treasury note yield. Treasury yields are lower than they might otherwise be because a declining federal deficit has reduced the number of bonds in the market.
Also, some investors, fearful of year-2000-related disruptions outside the United States, may be snapping up U.S. Treasuries in a “flight to quality” hedge. The smaller supply combined with higher demand pushes up bond prices, which move in the opposite direction of bond yields.
Waiting to lock in a mortgage rate is always a gamble, but Peattie said he expects there to be lower rates in the next few months.
Financial advisors say house hunters worried about being priced out of the market might consider adjustable-rate loans or hybrid loans, which are fixed for a period of years before becoming adjustable. Rates on these loans are typically one-half to 1.5 percentage points cheaper than traditional fixed mortgages.
Rates for adjustable-rate loans are less vulnerable to bond market forces and thus slower to change, Peattie said. Although a few mortgages are tied to the prime rate, most use other benchmarks that are slower to rise and fall.
* Credit cards: 80% of the nation’s credit cards have adjustable rates, and most of those rates are tied to the prime rate. But customers who carry a balance don’t necessarily have to accept higher costs, said Robert McKinley, head of CardWeb.
Competition is fierce enough that consumers can sometimes lower their rates simply by asking their current credit card companies, especially if they mention lower-rate offers received in the mail from other companies, McKinley said. The card issuer might not match the 3.9% teaser rates popular today, but customers with excellent credit and an on-time payment history can get a lower rate, sometimes below 13% and even as low as 10%.
Bank Rate Monitor, which tracks interest rates, reports the standard fixed-rate card now charges 13.29%, while the variable version averages 16%.
If their current company won’t budge, consumers should consider moving their balances to a lower-rate card. But rate shoppers should carefully read the offer’s fine print, since some companies charge transfer fees or impose high rates if a payment is late, which could easily wipe out any savings from moving the balance, McKinley said.
As interest rates rise, consumers should make it a priority to pay off their most expensive debt, which is typically credit card debt, financial planners say. Unlike many mortgages, home equity loans or student loans, credit card interest is usually not tax-deductible.
* Other loans: Most home equity lines of credit have variable rates tied to the prime or other benchmarks that will reflect the Fed’s increase.
But rates for car loans have actually declined slightly in the last six months and may or may not rise in response to the Fed move; typically such rates are determined more by supply and demand, and stiff competition has checked rate increases.
* Savings: Rates on certificates of deposit and money market accounts were already on the rise this summer, thanks to the Fed’s first rate increase in June and anticipation of a second increase, said Peter Crane, managing editor of IBC Financial Data, which tracks rates.
Crane expects the upward trend to continue, with money market funds reflecting the full 0.25-point increase first.
“When the Fed hikes rates, money markets will take about a month to reflect the [total] increase. CDs move a little slower,” Crane said “It’s the old saw about banks being quick to cut rates and slow to raise them on what they’re paying you, and vice versa on what you’re paying them.”
Savers who don’t want to wait for their bank to take action can look around for higher rates. Capital One Federal Savings Bank in Falls Church, Va., currently offers a one-year CD yielding 6.27%, while Providian Bank in Salt Lake City has a similar CD with a 6.24% yield. Both banks require $10,000 minimum deposits. Net.Bank in Alpharetta, Ga., has a one-year CD yielding 6.15% with a $2,000 minimum deposit.
Crane recommended that savers be wary of putting too much money into longer-term CDs simply to get higher yields. In an unstable rate environment, it may make more sense to keep at least some of your savings in short-term investments, he said.
“The shorter the better,” Crane said. “If you’re locked into a five-year CD and the Fed keeps raising rates, you’re going to be sorry.”
* RATE BUMP: The Fed, as expected, nudged key interest rates upward. A1
* MILD REACTION: Bonds rallied and stocks were mixed after the Fed action. C4
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The Fed Effect
Here are key savings and borrowing rates as of Tuesday and on the previous two dates the Federal Reserve changed market interest rates: last Nov. 17, when the Fed cut its main short-term rate a quarter-point, and June 30, when it raised that rate a quarter-point.
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Interest rate Nov. 17 June 30 Tuesday Federal funds 4.75% 5.00% 5.25% Prime lending 7.75 8.00 8.25 Money market fund* 4.73 4.44 4.63 6-mo. T-bill 4.47 5.04 5.09 1-year bank CD* 4.58 4.77 4.98 30-year mortgage** 6.86 7.71 7.93 30-year T-bond 5.30 6.06 5.93
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* Average national yields from IBC Financial Data
** Freddie Mac average rate
Sources: Bloomberg News, Times research
The Fed’s Moves Since 1990
Here are changes in the federal funds rate since 1990. The fed funds rate is the rate banks charge each other for short-term loans. It is the primary market interest rate that is influenced by the Fed’s actions in tightening or easing credit in the economy.
Tuesday: 5.25%
Sources: Bloomberg News, Times research
