Falling interest rates may be a boon to borrowers, but they can be hard on savers and retirees on fixed incomes.
The Federal Reserve on Tuesday cut its key short-term interest rate three-quarters of a percentage point to 2.25 percent — a move designed to spur banks, credit card issuers and other financial institutions to lower their rates as well.
It was the sixth cut since September, and it pushed the rate a full 3 percentage points below the 5.25 percent that prevailed last summer.
Here’s how borrowers and savers are faring in the lower-rate environment.
Q: How does the Federal Reserve action affect the interest rates on consumer products?
A: When the Fed lowers its federal funds rate, which is the interest banks charge each other on overnight loans, the financial institutions typically pass on the lower rates to borrowers and savers. Shortly after the Fed acted, many of the nation’s big banks lowered their prime lending rate to 5.25 percent from 6 percent.
Q: Will consumers see lower rates on their credit cards?
A: Probably, but not right away, said Greg McBride, senior financial analyst with Bankrate.com.
“Card issuers tend to pass along rate increases more quickly than rate decreases,” he said. The lag is typically up to three months, and the reduction may not match the Fed’s cut, he added.
The average rate on a variable-rate credit card six months ago was 14 percent; now it’s about 12.35 percent.
Another maneuver that can reduce the benefit for consumers is that some card issuers switch to fixed rates from variable rates to keep their profits from dropping.
Q: What about home mortgage loans?
A: “The biggest beneficiaries of the repeated rate cuts are homeowners facing resets with adjustable-rate mortgages,” McBride said.
That’s because the rate on many of these home loans is pegged to the rate on the one-year Treasury bill, which tends to move down after Fed rate cuts.
“Last summer, borrowers with an adjustable-rate mortgage pegged to one-year Treasuries could have seen their rate jump by 3 percentage points,” McBride said. “Now, borrowers could see their rate decline.”
So a family with a $200,000 home loan would have seen a $370 increase in monthly payments if the rate adjusted last summer, but a loan that reset this spring would have a $50 per month decline, he said.
Q: Will fixed-rate mortgages be affected?
A: These loans typically reflect the rate on 10-year Treasury notes, and this is affected more by conditions in credit markets and inflationary expectations than by Fed action on short-term rates. Fixed-rate mortgages currently are being offered a bit below 6 percent now, not much of a drop from the high around 6.8 percent last July, Bankrate.com estimates.
Q: What about homeowners with lines of credit?
A: Borrowers with outstanding lines of credit should see their monthly payments drop as the rate on these loans falls in line with the prime rate, said David Tysk, a senior financial adviser with Ameriprise Financial in Minneapolis.
He said that a client with a $100,000 outstanding line of credit already has seen a $180 drop in his monthly payment and could see that rise to more than $200 after the latest Fed action.
Q: What about savers?
A: As the Fed has lowered rates, the return on savings accounts and many short-term investments has fallen, too.
Tysk noted that the yields on certificates of deposit are down and that investment alternatives such a municipal bonds and money market funds “are not doing well in the current climate.”
He said that what a consumer should do depends on his or her short-term needs — and comfort level.
Tysk said one concerned client recently moved a big chunk of his savings to federally insured bank accounts and government securities. “Consumer sentiment is very real,” he said.
Q: How are retirees and others living on fixed income feeling the pinch of lower rates?
A: “If you are a retiree, these are tough times,” Tysk said. That’s because returns on savings are down while costs — from gasoline to heating oil, health care and food — are rising.
The retirees, he added, are finding a variety of ways to cope.
Some have been borrowing, perhaps to pay for a new furnace or car, because paying a low rate on a loan beats paying tax of 25 percent or more on a withdrawal from an Individual Retirement Accounts or a company-sponsored retirement savings plan, he said.
“They also have an incredible ability to adapt ... delaying purchases, home projects, things like that,” Tysk said.
Q: Is the Fed finished?
A: Mark Vitner, senior economist with Wachovia Corp. in Charlotte, N.C., believes there’s room for further rate cuts.
“They probably have to overdo it, and then take some back later in the year or next year,” he said.
He described the Fed action to date as “a full frontal assault on the credit crunch” and added: “They’re hitting with everything they’ve got. It’s pretty remarkable. I think six months from now we’ll look back and marvel at how creative the Fed was and how successful they were.”