Smart steps after the Fed

Mortgages

Richard DeKaser, chief economist at National City Corp., urges all Americans fretting about the state of the economy to pause and take a deep breath.

“I don’t think overreacting is appropriate,” he says. “Calls for a return of the Great Depression are greatly exaggerated, in my view.”

Still, DeKaser does not downplay how surprised he is by the recent meltdown in the U.S. financial markets.

“Without a doubt, I did not see what happened in the month of September playing out,” he says.

Recent financial tumult prompted the Federal Reserve to act with an emergency 50-basis-point reduction in the target federal funds rate Oct. 8. The Fed’s open market committee voted 10-0 to cut rates in advance of the Fed’s next scheduled meeting Oct. 28 and Oct. 29.

The surprise rate cut was made in coordination with other central banks across the world, including the Bank of England, the European Central Bank and banks in Canada, Sweden and Switzerland.

The coordinated action signals growing recognition that the problems afflicting U.S. credit markets have spread across the world, according to DeKaser.

“It suggests a uniformity of response across the world,” DeKaser says. “This truly has become a global problem. Just as a unanimous vote of the (Federal Reserve) open market committee signals unity and resolve, so too does a widely dispersed rate action.”

DeKaser says the coordinated rate cut is just the latest in a series of moves by the Fed and the U.S. Treasury designed to restore faith to markets badly shaken by turmoil on Wall Street, especially the bankruptcy of investment banking giant Lehman Brothers.

“Arguably, a lot of this had to do with the execution of the Lehman failure,” he says. “The traders I know on the fixed-income desk really believe that the Lehman failure — and its repercussions into money market mutual funds, then into the commercial paper market, then into interbank funding market — really rippled in such a way as to just great demoralize confidence. And it took on this downward spiral.”

As a result, there is a widespread “unwillingness to take on long-term commitments,” DeKaser says. Evidence of such fear can be found in recent economic indicators ranging from rising initial claims for unemployment insurance to dropping employment levels and sliding housing activity.

“The common thread here is that anything that requires some degree of confidence just abruptly fell of the table,” he says.

Now … or never?

The Fed’s emergency rate cut itself is unlikely to impact mortgage rates significantly, as cuts in the federal funds rate do not directly affect mortgage rates.

This is especially true of fixed-rate mortgages. While such mortgages sometimes decline in the wake of a Fed rate cut, they are just as likely to rise.

By contrast, adjustable-rate mortgages can be a bit more sensitive to Federal Reserve rate decisions. Many ARMs are pegged to the London Interbank Offered Rate, more commonly known as LIBOR. LIBOR rates usually closely track the federal funds rate. However, today’s economic turmoil has caused the spread between LIBOR and the federal funds rate has become uncharacteristically wide, meaning many people with ARMs will not see their mortgage costs fall as they typically would after a Fed rate cut.

The recent cascade of negative financial news has left many Americans shell-shocked. DeKaser says Americans will have to look at their own economic situation and decide for themselves whether or not now is the right time to buy.

“It’s going to depend on the individual,” DeKaser says. “For those who are feeling very secure in their situation, of course they should proceed as planned.

“But on the margin, there are going to be more people who are less secure. Those folks are going to have to do their own calculations as to what there prospects are going to be.”

Take-away

After leaving rates unchanged for several months, the Federal Reserve surprised many observers by cutting the target federal funds rate by 50 basis points.

The move is thought to be a reaction to recent turmoil in the world’s financial markets.

The central bank’s rate cut will not have a direct impact on mortgage rates. Rates may fall, but they could just as easily rise.

Bankrate’s rate tables can help you compare mortgage rates in your area.

Bankrate can also help you calculate whether a fixed-rate or adjustable-rate mortgage is better for you.

To determine whether refinancing is right for you, use Bankrate’s mortgage calculator.

— Chris Kissell

Smart steps after the Fed

Home Equity

The Federal Reserve’s decision to cut rates by a half-point caught many people by surprise. The Fed was not scheduled to meet until late October, and no action had been expected before then.

However, the recent near-meltdown of the financial markets may have forced the Fed’s hand.

A lower federal funds rate is good news for borrowers who use home equity lines of credit. Rates on HELOCs typically are tied to the prime rate, which moves in tandem with the federal funds rate.

So, if you need to borrow money, a HELOC may be your best option. Not only is the cost of borrowing now cheaper, but the interest associated with this type of borrowing is tax-deductible.

However, homeowners would be wise to borrow carefully. All signs point to coming economic hard times, and any type of debt can be toxic in such circumstances.

Bob Walters, chief economist at Quicken Loans, counsels American consumers hoping for a quick rebound of the financial system to be patient. “I don’t think there is going to be some kind of a silver bullet,” he says. “Some of this is just going to flat out take time.”

Take-away

The Federal Reserve cut interest rates after leaving them unchanged for months. That means borrowing costs on home equity lines of credit — which move in tandem with changes in the federal funds rate — should fall.

The uncertainty surrounding the fate of the financial system — and the U.S. economy — means Fed rate hikes are exceedingly unlikely in the near future.

For this reason, HELOC borrowers should expect costs to remain low for some time.

Meanwhile, changes in the federal funds rate do not directly impact existing home equity loan rates (which remain fixed) or rates on new loans. However, these rates have been climbing in recent months and may continue to do so.

Confused about whether to refinance or take out a home equity loan? Learn more in the Bankrate article “Refinance vs. home equity loans.”

Compare HELOC rates using Bankrate’s calculator and learn more about how to deduct interest on home equity debt in the Bankrate article “Taxes on home equity.”

— Chris Kissell

Smart steps after the Fed

Auto Loans

Shopping for an auto loan is the same no matter what the Fed does. To get the best deal, show up with a very good credit score and shop around.

Randy Ellsperman, chief financial officer at FirstAgain.com, an Internet-based lender, suggests checking online before going to the brick-and-mortar banks.

Though slightly self-serving, it’s good advice no matter which online lender you decide to visit. The applications are quick and offer an almost instant answer for borrowers.

“Determine what your options are. Don’t just go to one bank, don’t just go to the dealership and take their interest rate,” says Ellsperman.

“You would be forearmed to know what your options are, and a lot of companies will approve you prior to completing the auto transaction, so then you have at least one benchmark,” he says.

Online or otherwise, an excellent credit score will net the best loan but a hefty down payment will also help.

Buyers with less than perfect credit reports will almost definitely need to put down a significant down payment. To find out how a down payment will affect your monthly payments, use this Bankrate calculator.

Take-away

Just like getting pre-qualified for a mortgage, shopping first for the loan will allow buyers to get an idea of the rates available to them as well as the amount of money a lender is willing to offer.

“The whole auto purchase is an exciting and emotional process. It’s going to be one of the largest purchases someone makes,” says Mike Celuch, chief financial officer of Paragon Federal Credit Union in New Jersey.

“That’s why it’s better to take time to know what rate they can qualify for and how much they can actually afford before they get too excited or emotional. At the dealer they will be a lot more comfortable making the purchasing decision on that car,” he says.

— Sheyna Steiner

Smart steps after the Fed

CDs and MMAs

Shop for high-yield CDs.

Many banks are advertising CD yields that are well above those of traditional CDs. Add a few high-yielding CDs to your portfolio and you could see some nice returns in this dismal environment.

There are approximately 20 banks offering one-year CDs with yields of 4 percent or better on Bankrate’s high-yield database.

Wachovia, and several other banks, are paying more than 5 percent on five-year CDs.

“I think you’ll see good yields on the longer end of the yield curve for a while,” says Larry Fuschino, director of savings deposits at Wachovia. “I think all banks have realized that now is the time to try to lock in as many customers as possible to somewhat of a term situation, so we’re seeing a lot more competition than we saw even a month ago.”

Since Washington Mutual just went belly up, it’s a good time to point out that you must stay within FDIC limits if you want all of your deposits insured. WaMU customers who were over the limit lucked out because JP Morgan Chase accepted the uninsured deposits, but don’t count on that being the situation all the time.

If you want to keep your money liquid, check out Bankrate’s listing of high-yield money market accounts, some of which are paying more than 3.5 percent.

Take-away

Do some homework before buying a CD.

If the Fed sees the need to cut rates again it will get tougher and tougher to find decent rates. Even banks that need money will be able to lower their rates. Stick with maturities that meet your cash needs and your risk tolerance.

Tired of managing your own portfolio? Consider using a Certified Financial Planner.

— Laura Bruce

Smart steps after the Fed

Credit Cards



The Federal Open Market Committee, or FOMC, surprised us with by cutting the federal funds rate by 50 basis points after leaving it unchanged at the last three meetings. So what does this mean for you and your credit cards? Get conservative with credit card spending and aggressive with payments.

If you receive a small interest rate reduction, great. Regardless, now is the not the time to carry a large balance relative to your credit limit. “It’s risky because all of a sudden you are setting yourself up to be assessed at a higher risk,” says Bill Hardekopf, CEO of LowCards.com.

While the lower the balance the better, most experts recommend keeping balances under 30 percent of your limit. High balances can lower your credit score and trigger rate increases or credit limit reductions. Even if you pay off your card each month, the amount reported to the credit-reporting agencies is what matters. Depending on when the issuer reports, that amount could be your statement balance.

Learn smart strategies for paying down debt. Use our debt payoff calculator to compute how long you’ll be making payments.

Also, the majority of credit card issuers are whacking credit limits, so make sure you know what yours is. “I think even if your credit is good, you’re still vulnerable,” says Curtis Arnold, founder of CardRatings.com and author of “How You can Profit from Credit Card.”

Check your statement or call your issuer to find out what your credit limit is. If it gets reduced, call your issuer to complain.

That goes for any adverse action. Call your issuer to reverse unfair changes, citing your consistent payment history, longtime customer relationship or anything you can use as leverage. Shop around for a new card when that doesn’t work.

Take-away

The best defense against tightening credit and uneasy issuers is a good credit offense. Reduce your balances, make payments on time and spend less than 30 percent of your credit limit, or lower.

— Leslie McFadden

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