Fed’s Stance Is a Boon for Consumers--for Now

By leaving its key short-term interest rate alone for now, the Federal Reserve is doing a favor for millions of consumers with home-equity and credit card rates pegged to the prime lending rate.

The stronger economy already has boosted other interest rates, reflecting investors’ belief that demand for loans will rise and that inflation--a tame 1.6% last year--could reemerge. The yield on the benchmark 10-year Treasury bond is up more than a percentage point since early November, to 5.29% on Tuesday. And mortgage buyer Freddie Mac says the rate on a standard 30-year home loan has risen from 6.45% to 7.08% during the same period.

But the prime rate--the interest rate banks charge their best customers and the benchmark for many types of short-term loans--remains 4.75%, three percentage points above the federal funds target rate, the Fed’s key short-term rate. And that should help keep short-term borrowing costs near their current low levels, at least for now.

The Fed, which lowered the federal funds rate 11 times last year to stimulate the economy, left it unchanged Tuesday at 1.75%, the 40-year low where it has been since Dec. 11.

However, the Fed also shifted its stance on the economy to “neutral,” meaning it believes the outlook is evenly balanced between recession and excessive growth. By shifting its so-called bias, the Fed signaled it may raise rates if the economy continues to heat up, and economists expect several increases during the second half of the year.

A rate increase would raise the current rock-bottom rates for home equity lines of credit, which have boomed in popularity as home prices have risen, allowing more people to borrow against the value of their homes.

Federal Reserve statistics show home-equity lending at commercial banks has risen more than 60% since the end of 1999. For borrowers with strong credit, most of those loans have interest rates one to one and a half percentage points above prime--meaning in the 6% range currently, compared to 10.5% to 11% when the Fed began cutting rates last year.

Banks could raise the prime rate even if the Fed doesn’t make any increases, but that’s highly unlikely, industry experts said. Rick Hartnack, vice chairman of Union Bank, said it’s also unlikely that many banks will increase their rates on home-equity loans until the Fed makes a move. Even though other rates are rising, the home-equity business is highly competitive, he said.

The American Bankers Assn. says about half of credit cards also have variable interest rates based on the prime rate. But credit card customers have benefited far less from low short-term rates.

Many card issuers didn’t match the final Fed rate cuts last year because their cards have interest rate floors. Though consumer advocates complain of price gouging, the issuers contend they need the minimum rates because of high marketing and administrative costs and the fact that delinquencies rise during economic downturns.

“Many companies had seen those floors reached last year and stopped lowering their rates,” said Lynn Reaser, senior economist for Banc of America Capital Management.

Credit card rates already have started inching up along with nearly all other credit types, said David Littman, chief economist for Comerica Bank.

Reaser and economist Doug Duncan of the Mortgage Bankers Assn. expect fixed-rate mortgages to climb to 7.5% by year end, an increase that mainly will affect refinancings. A record $1.1trillion in home loans were refinanced last year as interest rates plummeted, a level expected to fall to $600 billion this year, Duncan said.

By contrast, the volume of mortgages used to purchase homes is expected to remain about the same as last year: $900 billion.

Economist Robert Goodman of Putnam Investments said that even if mortgage rates hit 8%, they’ll still be a great deal. After accounting for the tax benefits and the fact that housing prices are rising more than 5% a year in most parts of the country, the effect for homebuyers “is as if the cost of borrowing is zero,” he said.

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Tracking the Prime Rate

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