Best moves to make now while rates aim lower

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So if rates are headed lower soon, what can consumers do about it now?

Start mapping out strategies that minimize their overall borrowing costs and maximize their savings returns. Any time the Federal Reserve Board shifts its interest rate policy, Americans need to evaluate their financial situation and see if changes need to be made.

Here are some common financial products and strategies that apply given the current interest rate outlook, straight from experts.

Fixed-rate mortgages: If you’ve been shopping for a loan lately, you know mortgage lenders anticipate Fed interest rate cuts well before those cuts actually occur. Thirty-year rates fell below 8 percent in August and have continued to decline. As of mid-December, they’re about a quarter of a percentage point below where they were when the Fed started raising rates last June!

Best move now: Mortgage rates will probably keep falling as long as it appears the Fed will have to cut the rates it controls directly to prevent the economy from tanking. On the other hand, rates could stabilize if economic data released over the next several weeks shows that the economic slowdown isn’t as severe as people think.

Either way, rates almost certainly won’t rise. Both current homeowners who are planning to refinance and home buyers shopping for property right now should figure out if they qualify for a mortgage. But they should refrain from locking in a rate for as long as possible in order to take advantage of any further rate declines.

Adjustable-rate mortgages: In the current rate environment, taking out an ARM makes little sense. While rates on long-term fixed-rate mortgages start dropping well in advance of Fed rate cuts, rates on short-term ARMs don’t decline until cuts appear imminent or actually take place. In fact, rates on 15-year fixed mortgages in mid-December were lower than rates on 1-year ARMs! That means ARM customers aren’t getting any rate or payment advantage by taking on the risk of future rate increases.

Best move now: For now, forget ’em! Go with a long-term fixed rate loan. At 7.42 percent on Dec. 13, 30-year fixed rates were almost 40 basis points below their five-year average of 7.81 percent, according to data. Even though rates on 1-year Treasury Bills — which many ARM rates adjust to after their initial fixed-rate periods end — will probably fall when the Fed cuts rates, they likely won’t fall far enough to make ARMs the better mortgage choice.

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 of this, people with variable-rate credit cards may see their interest rates decrease very quickly by the same amount as any Fed decrease.

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 following any rate cuts by the Fed. Some variable credit card accounts are repriced shortly after the Fed changes rates. Other accounts are repriced quarterly so you may have to wait awhile to enjoy those lower interest rates. The average variable-rate standard card had a rate of 17.36 percent on Dec. 14.

Auto loans: research shows that interest rates on new-car loans tend to shift in lock step with the prime rate. If the prime rate drops by 50 basis points, expect rates on auto loans from financial institutions to follow suit almost immediately.

Not all car loans are tied to the prime rate, however. And 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 slowing auto sales. 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. Used car loan rates averaged 10.01 percent on Dec. 14 while rates on 48-month new car loans averaged 9.24 percent.

Home equity loans: Home equity rates tend to follow the prime rate. Because it changes within a day or two of a Fed cut, 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: Try holding off on borrowing for as long as possible. Rates on home equity loans should fall steadily over the next several months as the market reacts to Fed rate cuts. Homeowners with low loan-to-value first mortgages may want to consider “cash out” refinance mortgages instead of new home equity loans too.

A cash-out borrower can refinance, say, a $60,000 first mortgage on a $125,000 home, into a new $80,000 first mortgage and take $20,000 out at closing rather than keep the $60,000 first mortgage and take out a new $20,000 second. Doing so may cost less because first mortgage rates — which are already typically lower than second mortgage rates — are even lower, relatively speaking, today. That’s because first mortgage rates are sensitive to market expectations and have already fallen in anticipation of Fed rate cuts whereas home equity rates adjust largely to actual cuts and therefore haven’t really dropped yet.

Equity loan rates averaged 9.6 percent on Dec. 14.

Home equity lines of credit: Both new and existing line of credit customers will pay less if the Fed starts cutting rates because almost all home equity lines of credit feature variable payments and rates like credit cards. The average rate on a line of credit was 8.92 percent on Dec. 14.

Best move now: If it’s variable, it’s probably headed down. If the borrowing choice comes down to “home equity loan vs. home equity line of credit,” go with the line of credit. That way, your payments and rate will drop as the Fed cuts rates.

CDs, savings accounts, money market funds: Interest rates on certificates of deposit aren’t nearly as sensitive to Fed rate juggling as mortgage rates are, but they eventually do follow the trend. Someone once compared CD rates to an ocean freighter. They don’t just turn around and head in the opposite direction. It takes time.

This year, CD investors have enjoyed fairly high interest rates. In fact, it’s still easy to snag 12-18 month CDs with a 6.5 percent rate. Yet, right now, the big old freighter is turning and rates are starting to fall.

Best move now: If Alan Greenspan and his colleagues opt for a series of rate cuts — and that’s a big “if” considering George W. Bush is talking a huge $1.3 trillion tax cut — we could see the trend gain momentum. In any event, there doesn’t appear to be any reason for CD rates to rise in the near future so this is a good time to latch on to the highest long-term CD rate you can find and lock it in.

— Posted: Dec. 15, 2000