Drop in Interest Rates Cuts Both Ways

By Rackl, Lorilyn | Daily Herald (Arlington Heights, IL), September 30, 1998 | Go to article overview

Drop in Interest Rates Cuts Both Ways


Rackl, Lorilyn, Daily Herald (Arlington Heights, IL)


Byline: Lorilyn Rackl Daily Herald Staff Writer

The Federal Reserve's cut in interest rates Tuesday could be a double-edged sword for many consumers.

While they can look forward to lower borrowing costs down the line, the flip side is diminished earning power for those already getting skimpy returns on their savings.

Some interest rate watchers say savers will be the first to feel the effects of Tuesday's rate cut.

"Savings rates are apt to drop faster than borrowing rates, as they have in the past," said Robert K. Heady, veteran interest rate tracker and author of "The Complete Idiot's Guide to Managing Your Money." "It's going to take at least two months to feel the full effect ... on the borrowing side."

Largely to inoculate the U.S. economy from a spreading global crisis, the Fed on Tuesday did what many had predicted. It shaved a quarter percentage point off what is known as the federal funds rate, or the interest banks charge each other on short-term loans, to 5.25 percent.

Wall Street, which had hoped for a bigger rate cut, sent stock prices plunging by more than 100 points after the Fed announcement, but the market rebounded as the day wore on. The Dow Jones industrial average ended Tuesday down 28.32 at 8,080.52.

For consumers, the Fed's move can trigger a ripple effect.

Credit card bills, adjustable rate mortgages and car loans are just a few of the things that tend to follow whatever direction the Fed sets when it tinkers with interest rates.

The prime rate, which is the benchmark rate used by banks to set interest charges on most consumer loans, generally falls in lock step with any changes in the federal funds rate.

That's why the prime - currently at 8.5 percent - has already dropped to 8.25 percent at some major banks.

That means consumers can expect the rates on home equity loans, some credit cards and car loans to start heading south.

Adjustable-rate mortgages also are likely to drop, but consumers won't see the benefits of that until the lenders' next adjustment date.

Many experts agree the Fed's rate cut isn't going to do much to conventional fixed-rate mortgages, which already are at their lowest levels since 1968.

"Mortgage rates generally don't go lock step with short-term rates," said Mark McCarthy, an accounting professor at DePaul University who teaches personal finance classes. "Long-term rates are set more by market forces."

If the Fed continues to shave rates, which many economists expect to happen during the next year, that could put enough pressure on long-term mortgage rates to eventually push them even lower.

"I think they're going to ease down - we haven't seen the bottom yet," said Marve Stockert, executive director of the Lombard-based Illinois Association of Mortgage Brokers.

Rates in the Chicago area now average around 6.625 for a fixed 30-year mortgage.

Stockert said he wouldn't be surprised to see those rates fall as low as 5.75 percent. Rates like that are bound to open the floodgates for a rash of refinancings, he added.

What is good news for borrowers can be a curse for others, particularly those gleaning paltry earnings from their savings.

"The downside of lower interest rates is a drop in income, say for older folks who invest heavily in CDs," McCarthy said. …

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