Interest Rates, Mortgages, HELOCs, Credit Cards, and the Fed

The-FedOriginally published 12/17/2008, this post is being kept for its historical value, as the economy was still reeling from the housing market collapse and subsequent market swoon. For fun (and education), pull out your favorite charting tool and set the dates to either side of this date. This rate cut will mark the bottoming of the stock market (by March of 2009).

Days like yesterday and today are why I write the Finance Gourmet.  For those of you who didn’t see it, the Federal Reserve, or Fed cut interest rates to between 0% and 0.25%.  All day today, the media has been droning on about what it means for consumers, homeowners, and the economy.  Unfortunately, they are in such a hurry to do so, that they skip over all the details.  So, here it is, what the Fed’s rate cut means to you.

  • Interest Rates – Overall, short-term interest rates should fall in response to the Fed’s move.  Pay special attention to that important detail.  The monetary policy set by the Federal Reserve directly affects only short-term interest rates.  Long-term interest rates are set by the markets and the markets don’t always care what the Fed does, because the markets are not interested in what the interest rates are today, they care about what they will be in the future.
  • Mortgages – Mortgages are long-term loans and as such, their rates follow long-term interest rates, particularly the 10-year treasury. If you read the Interest Rates section above closely enough, you know why this is a big deal.  Just because the Fed cut rates does not mean that mortgage rates are going down. Normal mortgage interest rates will adjust slowly.  (See the next point).
  • ARM or Adjustable Rate Mortgages – The entire purpose of adjustable rate mortgages or ARMs is to eliminate the long-term nature of a mortgage’s interest rate.  By adjusting the interest rate at regular intervals, the lender has no risk of locking in dollars at a rate lower than current rates.  The flip side of this equation can be the lowering of the mortgage rate as well, but many mortgages have language limiting the amount this can drop. This may be the lowest mortgage interest rates you will see in your lifetime. Seriously consider getting a fixed-rate 30-year mortgage.
  • Home Equity Line of Credit – Also known as HELOCs and not to be confused with home equity loans (which are usually fixed interest rate) these are the loans that are most likely to be affected by the Fed’s move.  Many of these loans have an adjustable interest rate set at PRIME + some percentage.  Unlike other market based interest rates, the PRIME rate moves almost immediately in the direction and magnitude of any Fed rate cut or increase. Borrowers with this type of loan may see some relief, however some of these loans have minimum rates as well.
  • Credit Cards – This one is pretty much wishful thinking.  Most credit card interest rates are “fixed” because the credit card company can actually change the interest rate any time it wants to.  This is one of the most unfair practices in the credit cards industry, but until the politicians in Washington make them change how they do business, don’t expect any changes.  If you happen to have a credit card with a PRIME + something rate, there may be a change, but virtually all credit card accounts have a minimum, or floor, interest rate, which has probably already been hit, so your rate isn’t going down.

What To Do Now That Interest Rates Have Been Cut

After reading the above, you should be aware that there are no quick and easy, or automatic solutions coming based on this rate cut.  Frankly, that isn’t really what it is supposed to do.  But, that doesn’t mean there is nothing you can do.

First, don’t count on the rate cut to change the interest rates on any of your current accounts.  Instead, check now, and keep checking to see if you can get a new account with a better rate.  If so, then applying for that new account may make sense.  Feel free to call your current lender and see if they will lower your rate, but don’t hold your breath.  Things have changed from a couple of years ago when saying “boo” to your lender got them to change the rate.

Second, if you do have an adjustable rate mortgage or HELOC, now is the time to pull out the documents you got at your closing and find out what your minimum rate is, and the day on which the rate is set, and the date on which the rate is changed (they most likely will not be the same.)  This way, you will know what to expect.  Most interest rates are reset based upon the Wall Street Journal published Prime interest rate on a certain day.  So, your mortgage may set the rate on the 1st Monday of the quarter, or the first Monday of the year, or whatever.  Since the cut came in December, it is possible that your rate will change if it is measured in January.  However, if you rate was measured before December 15, for an adjustment to occur on January 1, you just go screwed.  Make sure to keep looking around for better rates, and consider whether a fixed-interest rate mortgage is right for you.

Third, if you have a fixed home equity loan (or a HELCO with a high floor interest rate), now is the time to check around on HELOCs.  Assuming you can get a much better rate and no (or very low) closing costs, it might make sense for you to roll over your home equity loan.  You can always go back to a fixed rate product when interest rates start rising again.  They didn’t come all the way down to zero all at once, and they won’t go all the way back up to 5% all at once either.  In the meantime, it might save you a good chunk of change.

Lastly, do not cancel credit cards (unless they have an annual fee, and then cancel them now) until you have replacements in hand.  With the current environment, banks and lenders are not necessarily making intelligent decisions and you may find it difficult to get new cards even with pristine credit and good ratios.  So, get new ones first, then cancel the old ones.

Most importantly, don’t get sucked up in the media hype.  The sky is not falling.  Things will come around again, they always do.  Do not listen to comparisons to the Great Depression.  The Great Depression not only had a stock market crash, but bread lines, and scores of bank failures.  The entire number of bank failures in 2008 still does not compare to the number of bank failures during the Great Depression, and unlike then, not a single account holder has lost a single cent.  This is not the same as then. That doesn’t mean there won’t be something new and bad that happens, but you can bank on the fact that it won’t be the same.


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