After the Fed news — what to do now

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As the economy continues to founder, the Federal Reserve Board keeps whacking interest rates in an effort to make things right.

Those rate cuts can make a significant difference in your financial situation, but only if you know what to do about the changes.

That’s why we’re here. To help answer those questions, we’ve outlined the financial steps people can take to capitalize on the nine rate cuts the Fed has made in 2001.

People who plan to take out home equity lines of credit, auto loans, mortgages or other loans anytime soon should pay attention. We’ve also included advice for consumers holding credit cards and savers looking to maximize their return on certificates of deposit and money market accounts.

All of the tips and figures below come from’s staff of financial experts and database of consumer interest rates.

Fixed-rate mortgages: Fixed-rate mortgages are at their lowest in three years. The 30-year fixed rate was 6.7 percent on Sept. 26, the date of’s latest weekly benchmark survey. That’s the lowest since the first week of October 1998, when the average rate dipped briefly to 6.46 percent, then started to rise.

Long-term mortgage rates follow changes in long-term bond yields (which move up and down daily based on what various indicators and reports say about the state of the economy), not changes in the federal funds rate, which is one of only two rates the Fed controls directly.

In fact, long-term mortgage rates sometimes move in the opposite direction of the federal funds rate. Sometimes they move in the same direction.

Best move now: Any time you can get a loan for less than 7 percent, you should consider locking in. Rates could fall further by the end of the year or early 2002, but at some point bond traders are going to start worrying about inflation in the years ahead.

More than half of the people applying for mortgages nowadays are refinancing. If you can cut a couple of points off your interest rate by refinancing, it might be time to join the bandwagon.

Here’s another bit of advice: Know what you can afford in a home and a loan, and don’t take a deal that won’t work for your budget.

When you’re ready to buy, try the
mortgage search engine to locate the best deal.

Adjustable-rate mortgages: ARM rates started responding to the Fed’s aggressive rate cuts earlier this year. That’s because they tend to follow changes in short-term rates, such as the yields on short-term Treasury bills and notes (which track the federal funds rate closely).

With the Fed unlikely to raise rates anytime soon, ARM rates should stay low or even go lower over the next couple of months.

Best move now: Someone who plans to live in a house for only a couple of years might want to consider a short-term ARM now that rates on such loans have fallen. The same holds true for someone who needs a little extra help getting into a home.

But fixed rates are very low by historical standards. Borrowers with a longer-term horizon should probably lock in a low rate for 30 years rather than get an ARM with a rate that has a good chance of rising from current levels.

One-year ARMs averaged 5.67 percent on Sept. 26 in the national weekly survey. You can search for the
best ARM rates in your area.

Home equity loans: Home equity loan rates tend to follow the prime rate, though rates on longer-term loans (those with terms of 10 years or 15 years, for instance) behave more like long-term, fixed-rate mortgage rates.

Because the prime rate changes within a day or two of a Fed cut, many new home equity loan customers will start seeing lower rates shortly thereafter. Existing borrowers, however, won’t see an impact at all because equity loans have fixed payments and rates.

Best move now: Earlier this year, we advised borrowers to hold off taking out home equity loans on the expectation the Fed would keep cutting rates. The rationale was simple: When the Fed is cutting rates, equity loan borrowers can get lower rates by waiting until the end of the rate-cutting cycle.

Many economists expect the Fed to cut rates again in November or December. If you can afford to wait, you might want to keep waiting. Remember, you’ll find the lowest rates on the shortest-term loans (say, three to five years).

If you can’t afford to wait, hey, the rates probably aren’t going to get a whole lot lower, so you’re still getting a good deal.

Equity loan rates averaged 8.84 percent on Sept. 26. Use Bankrate’s
equity loan search engine to find the best rates in your area.

Home equity lines of credit: Most equity lines of credit feature variable rates and payments tied to the prime rate, which declines whenever the Fed cuts rates. The prime rate will probably bottom out late this year, but don’t expect your HELOC rate to hit 3 percent.

Best move now: Home equity lines of credit continue to be a good option for borrowers. The Fed has cut rates nine times this year, and might cut the rate one more time. That means variable-rate lines of credit could drop even further, so you might want to wait to lock into a fixed rate.

Equity line of credit rates averaged 6.54 percent on Sept. 26. You can search for the lowest
home equity line of credit rates in your area.

Credit cards: Experts say about 70 percent of all credit cards are variable-rate cards and most of those are linked to the
Wall Street Journal prime rate, which usually falls the day after the Fed cuts rates.

Because many variable-rate cards are re-priced each quarter, many card customers had to wait until April to enjoy lower rates stemming from the three interest-rate cuts in the first quarter of 2001. And they had to wait until July for the rate cuts in the second quarter to kick in. A new rate cut will mostly show up in December card bills. So these folks will have to be patient, yet again.

Other credit card customers are more fortunate. Their variable cards are re-priced monthly. These customers will see their rates drop very quickly by the same amount the Fed decreased rates.

Still, with all the rate cuts this year, some card customers have hit the minimum annual percentage rates allowed in their cardholder agreements. The interest rates on their cards won’t drop any lower. Some variable rate cards come with minimum APRs or floors and some do not. Be sure to check your cardholder agreement.

Best move now: Consider transferring a balance to a low, variable-rate credit card. A variable-rate card that beats the rates on any other card in your wallet will be an even better deal should the Fed cut rates again. The average rate on a standard variable-rate card was 14.12 percent on Sept. 26, while the average rate on a standard fixed-rate card was 14.25 percent. Compare credit cards using Bankrate’s
credit card search engine.

Car loans: research shows that interest rates on new-car loans tend to shift in lock step with the prime rate. If the Fed cuts rates, the prime rate drops and rates on auto loans from financial institutions soon follow suit.

Not all car loans are tied to the prime rate, however. Even with a drop in interest rates, few banks and finance companies will be able to match the super-low financing deals available from captive finance companies of auto manufacturers, such as Ford Motor Credit and General Motors Acceptance Corp.

Best move now: If you’re arranging financing for a new car, don’t ignore dealer financing. Auto manufacturers are rolling out the deals in an attempt to bolster auto sales.

If you have an outstanding car loan, you may want to consider refinancing. Keep in mind that used-car loans are slower to follow the prime rate’s moves and may not change for a month or two. Even when a shift in rates occurs, it may be less than the prime rate swing.

Rates on 48-month new-car loans averaged 8.81 percent on Sept. 26, while rates on three-year used-car loans averaged 9.87 percent. Use our search to find the
best car loans in your area.

CDs, savings accounts, money market funds: Interest rates have fallen, and they can’t get up.

Best move now: The national average returns for six-month, one-year and five-year CDs are at their lowest point since began tracking them in 1984.

If you have a laddered CD portfolio and need to replace the five-year maturity, continue laddering but consider substituting an I Bond for the five-year maturity that’s rolling over.

I Bonds will pay 5.92 percent for six months if you buy before Nov. 1. The 3 percent fixed-rate will continue for the life of the bond, but the inflation-indexed premium, which is now 2.92 percent, is subject to change every six months.

If you’re interested in a short-term (less than one-year) CD, it may be better to put the money in a money market account or fund. The interest rate isn’t that much lower than a short-term CD, and you’ll have liquidity so you can reinvest the money quickly should the economy turn around and rates start going back up.

One-year CD yields averaged 2.94 percent on Sept. 26, while money market account yields averaged 1.55 percent.
Click here for CD rates in your area.

— Posted: Oct. 2, 2001