The Fed Rate Cut: How Soon Will It Affect You?

Wednesday, October 29, 2008

The Federal Reserve has cut interest rates by 50 basis points. What do you need to do about it, and how soon will the cut affect your finances?

Mortgages:

Federal Reserve cuts in the federal funds rate have an unpredictable effect on long-term mortgage rates. So it's impossible to know for sure when -- or even if -- rates will fall as a result of the Fed's rate cut.

Fixed-rate mortgages usually do not change in response to cuts in the federal funds rate. However, adjustable-rate mortgages may be more sensitive to Federal Reserve rate decisions.

Depending on the exact nature of their mortgage, some people with ARMs may see their rate adjust downward the next time the mortgage resets.

Conclusion:

It's impossible to know when -- or even if -- fixed-rate mortgages will fall given the Fed's most recent trim to the federal funds rate. However, it's possible that some homeowners with adjustable-rate mortgages will see lower payments the next time their mortgage rate resets.

Home Equity:

The Federal Reserve's decision to cut rates by a half-point eventually will mean lower borrowing costs for homeowners who have a home equity line of credit.

Most home equity lines of credit are indexed to the prime rate, a common benchmark for consumer and business loans set by banks. The prime rate moves in lock step with the federal funds rate.

However, don't necessarily expect your HELOC rate to drop overnight. In some cases, it may take one or two billing cycles before consumers see borrowing costs fall.

Rates on new home equity loans are trickier to forecast, as they do not move in lock step with the federal funds rate. In addition, people with existing home equity loans will not see their borrowing costs fall, as rates on these instruments remain fixed.

Conclusion:

The Federal Reserve's latest interest rate cut means you can expect HELOC rates to fall soon. It may take one or two billing cycles before you see the benefits.

Auto Loans:

The key to getting the best possible auto loan in today's market, as it has been for months now, is to bring a sterling credit score with a sizable down payment.

Today's rate cut likely will not translate into a savings bonanza for car buyers.

"I don't expect much for rate reduction generally," says Randy Ellspermann, chief financial officer at FirstAgain.com. "In a normal economy, a rate cut would probably be passed along in the form of lower auto rates by many of the people who make auto loans."

These days, however, keeping banks lending to one another seems to be the most important issue. "I do think that perhaps some of the credit unions who are not as affected by this liquidity crisis may lower interest rates," Ellspermann says.

Bill Vogeney, chief lending officer at Ent Federal Credit Union, says that rates may go down at his credit union, if all signs point to go. "It will depend; we look at not only Fed moves but also alternative investments. If we don't lend the money we have to invest it, but we have to look at what competitors are doing and our cost of funds," he says.

"If everything works out, it may point to a rate decline, but -- I think other lenders are going through this -- our rates will drop for borrowers with the absolute best credit, 720-plus FICO scores, and only for shorter term loans, 60 months, maybe 72," Vogeney says.

Conclusion:

Rates are likely to vary depending on the lender as well as your credit score and down payment.

Check all available avenues as well -- call around to local credit unions and go to online lending Web sites as well.

CDs & MMAs:

Certificate of deposit rates compete with other fixed-income options of like duration -- namely Treasuries. Longer-term CDs, just as with longer-term Treasuries, often move in advance of the Federal Open Market Committee, if economic conditions are such that a rate change is expected. Shorter-term CDs and money market accounts

When rates are dropping, it's not a good idea for savers to postpone fixed-income purchases hoping the trend will reverse. On the other hand, plenty of caution is warranted if you believe we'll be moving into a rising-rate environment in the near future because if you buy longer-term maturities, you could get stuck with lower rates unnecessarily.

Let your time horizon and your cash needs dictate the maturities you buy.

Conclusion:

It will take time for all of the measures the Treasury and the Federal Reserve have put in place to do some noticeable good. Having enough cash on hand can be an enormous stress reliever in these rough times. Don't put up with low-yielding CDs; make your money work.

Credit Cards:

Those due to get a rate cut may receive one "as soon as the next statement cycle or as long as three statement cycles," says Greg McBride, a senior financial analyst for Bankrate.com. "Issuers have their own pricing policies."

Floor rates could prevent some variable-rate cardholders' APRs from falling, as could lower credit scores. Certain behaviors can trigger a rate increase or lower credit limit, such as paying late, habitually paying the minimum balance or charging close to the card limit.

Regardless of what happens, pay attention to your statements and any notices of a change in terms that arrive in the mail. Make sure your issuer hasn't made an unfavorable adjustment to your APR or credit limit. "If you see something change, call your credit card company and say, 'Hey I don't want that to change,'" says Emily Peters, credit expert for Credit.com.

Paying off balances not only saves you money, but also helps shield you from the impact of any negative adjustments to your account. Otherwise, Peters says, "be aware of what you're paying on these cards, and if it's really expensive, consider moving to a card that has a lower rate if you have the credit for it."

Make sure that your credit scores aren't lower because of a mistake. Check your credit reports for free at Annualcreditreport.com. You're entitled to one free copy from each of the three national credit-reporting agencies every 12 months. Because the information in your credit report determines your credit scores, you'll want to dispute errors and look for derogatory items that could be depressing your scores.

Conclusion:

Variable-rate cardholders eligible to receive a rate cut should receive it within three billing cycles.