Best moves to make when interest rates fall

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Most Americans know the Federal Reserve Board has slashed interest rates repeatedly this year. Unfortunately, many don’t know what to do about it.

To help solve that problem, we’ve outlined the financial steps people can take to capitalize on the seven rate cuts the Fed has implemented 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:
Rates on fixed-rate mortgages are near their lows for the year again after being stuck in a holding pattern for much of 2001.

They were stuck because 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. Many Wall Street experts have been expressing confidence all year that the Fed’s aggressive rate cuts would lead to an improving economy.

But lately, Wall Street’s optimism has been severely tested by a rash of negative economic data. So for the second time this year (the first time was in late March), average 30-year rates dropped below 7 percent in mid-August.

Best move now: Any time you can get a loan for less than 7 percent, you should consider locking in. Rates have a fair chance of rising by the end of the year or early 2002. After all, the Fed’s cuts should eventually have an impact. At the same time, rates could fall further if we do end up in a recession.

People who can afford to wait to refinance (i.e. those who don’t need to refinance for monthly payment breathing room, those who are sure they won’t lose their jobs and their ability to qualify for a mortgage) may want to do so.

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. Thirty-year rates averaged 6.96 percent on Aug. 15, the date of’s last weekly benchmark survey.

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 5.99 percent on Aug. 15 in the national weekly survey.
Click here to 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.

NNow that end may be nearing. That makes the next couple of months a great time to lock in a low equity loan rate. If you can afford to borrow, wait a couple of weeks for banks to adjust their rates to reflect the latest Fed cut, then pounce! But remember, you’ll find the lowest rates on the shortest-term loans (say, three to five years).

Equity loan rates averaged 8.95 percent on Aug. 15. Use Bankrate’s
equity loan search engine to find the best rates in your area.

Home equity lines of credit:
Both new and existing line of credit customers are paying significantly less to borrow today than they were in 2000. That’s because 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 is probably close to bottoming out, though, after falling so much this year. So don’t expect your HELOC rate to hit 3 percent.

Best move now:
While home equity lines of credit, rather than loans, were the better option for borrowers earlier this year, that may not be the case any more. Because the Fed has cut rates so many times already, it may want to stop soon and let those cuts work their magic.

Borrowers should give banks a couple of weeks to adjust their rates to reflect the Fed’s latest cut, and then lock in low fixed-rate equity loans. After all, if you get a variable-rate line of credit when rates are at or near a nadir, your risk of higher rates and payments in the future rises substantially.

At the same time, the prime rate could stay low for a longer-than-expected period. The Fed slashed the funds rate all the way to 3 percent in a rate-cutting cycle that ran through September 1992. Because the economy took a long time to rebound, the Fed didn’t start hiking the funds rate again until February 1994. If the same scenario plays out this time around, customers who get lines of credit won’t see their rates increase for a long time.

Equity line of credit rates averaged 6.96 percent on Aug. 15.
Click here to search for the best home equity line of credit.

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 October 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 14.69 percent on Aug. 15, while the average rate on a standard fixed-rate card was 14.61 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 8.86 percent on Aug. 15, while rates on three-year used-car loans averaged 9.95 percent.
Search here for car loans in your area.

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

Best move now:
Shop carefully before you buy. Check for the best CD rates across the country, then look for the best money market rates. Be sure to check Internet banks — they offer some of the highest rates around.

Short-term rates will continue to drop, while long-term (one-year or longer) may drop a basis point or two here and there, but are more stable than shorter-term CDs. Regardless, CD rates have taken a pounding, and it will be a while before they turn around. You may want to consider a money market fund; the rates aren’t great but you’re not locked in, either.

One-year CD yields averaged 3.52 percent on Aug. 15, while money market account yields averaged 1.73 percent.
Click here for CD rates in your area.

— Posted: Aug. 21, 2001