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Cut will aid homeowners

The Fed's action will result in lower rates on certain loans. Savers, however, will see a drop in their earnings.

September 19, 2007|Tom Petruno | Times Staff Writer

The Federal Reserve's interest-rate cut will help many people save money on home-equity credit lines and adjustable-rate mortgages -- but whether it will revive the troubled housing market is far from clear.

One risk is that the Fed's move Tuesday could ignite inflation fears, which could drive up conventional mortgage rates and make matters worse for housing.

"If the Fed does revive inflation it's going to put a damper on housing and other activity in the economy" by pushing up long-term rates, said Gregory Hess, professor of economics at Claremont McKenna College in Claremont.

In the short term, there will be some definite winners -- and losers -- as a result of the central bank's half-point cut in its key short-term rate, to 4.75%.

Savers will lose as their interest earnings decline. But homeowners who have home-equity credit lines will see their interest costs reduced almost immediately, said Greg McBride, senior analyst at BankRate Inc. in New York. That's because the majority of those credit lines are tied to banks' prime lending rate, he said.

Major banks including Bank of America, Wells Fargo, Citibank and others quickly reduced the prime Tuesday to 7.75% from 8.25%. They typically keep it three percentage points above the Fed's rate.

Many banks also link credit card rates to the prime, but card rates tend to be adjusted more slowly than home-equity loan rates, McBride said.

Some homeowners with adjustable-rate mortgages that will reset soon already were expecting a bit of relief, and the Fed's cut may ensure that they get it.

Many ARM loans are tied to an index of one-year Treasury bill rates. That index has fallen since midyear; it was 4.15% on Monday, down from 4.99% on July 23, according to the Fed.

Rates on Treasury securities have slumped because some investors have rushed into those issues as a haven amid global financial market turmoil, and because others bought Treasuries betting that the Fed would be forced to ease credit.

"The bond market was far ahead of the Fed," said Rick Keller, head of Keller Group Investment Management Inc. in Irvine.

Now, if the market anticipates more Fed rate cuts, it's possible the one-year Treasury index will fall further, experts say.

Paul McCulley, a bond fund manager at Pacific Investment Management in Newport Beach, said his firm expected the Fed to continue paring its rate to at least 3.75% in 2008 because of the threat the sinking housing market poses to the economy.

"This is not a one-and-done type of world," McCulley said of the rate-cut outlook.

But homeowners who have sub-prime ARMs with very low teaser rates, and who are facing a rate reset soon, may still be facing a new rate that's far more than they can afford -- 8%, say, instead of 8.5%, depending on how the loan is structured.

New home buyers and homeowners who want to refinance into a 30-year loan face the biggest question mark, because it isn't certain that the Fed's reduction in its short-term rate will translate into lower long-term mortgage rates.

That's because long-term interest rates are set by the marketplace, not by the Fed. And one key consideration of investors in determining long-term rates is what inflation rate they expect, because inflation eats away at bonds' fixed returns.

If investors think the Fed's credit-easing move could stoke the economy and boost inflation pressures in 2008, that could result in long-term rates rising, analysts warn.

For the beleaguered housing market, that would mean "putting it in a worse bind" than it already faces, said George Goncalves, Treasury-market strategist at brokerage Morgan Stanley in New York.

On Tuesday, the 10-year Treasury note yield inched up to 4.47% from 4.46% on Monday, even as short-term rates fell. Thirty-year mortgage rates tend to track the 10-year T-note.

Still, because the 10-year T-note yield has tumbled from 5.05% in mid-July, 30-year home loan rates also have fallen. They averaged 6.31% nationwide last week, down from 6.73% in mid-July, according to mortgage finance giant Freddie Mac.

Keith Gumbinger, vice president at loan tracker HSH Associates in Butler, N.J., said there may be another obstacle to lower mortgage rates: Some struggling lenders, he says, "won't be in any great hurry to pass along their savings" from cheaper money because they're trying to fix their own battered finances.

For savers, meanwhile, the Fed's rate cut is almost certain to mean that banks will trim the yields they pay on savings certificates, experts say. So some savers may want to lock in yields on longer-term CDs, depending on their income needs.

Those yields already have been drifting lower since mid-August as rates on Treasury securities have come down, in part anticipating the Fed's move.

The average annualized yield on a one-year, $25,000 bank CD nationwide now is 4.16%, according to rate tracker Informa Research Services.

The key is to shop around, BankRate's McBride said. Banks set their CD rates based on their funding needs, he noted, which means some may trim their payouts much less than others.

By contrast, yields on money market mutual funds are expected to fall across the board, assuming the Fed's move has the intended effect of lowering rates on the short-term corporate IOUs that many funds buy.

Money fund yields should decline by about half a point over the next eight weeks or so, said Deborah Cunningham, chief investment officer at Pittsburgh-based Federated Investors. The average seven-day annualized yield on money funds was 4.69% last week, according to IMoneyNet Inc.

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