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If you're in debt, you're in luck

The rate cut will bring relief to borrowers. Savers will lose.

January 23, 2008|Kathy M. Kristof | Times Staff Writer

For many Americans, the effects of the Federal Reserve's aggressive rate cut will be swift and striking. The average borrower could save hundreds of dollars within a few months -- and the average saver could lose just as much.

Fortunately, as far as the strength of the consumer-driven economy is concerned, there are fewer people relying on the income earned by their investments than there are people heavily in debt. With $2.5 trillion in consumer debt outstanding -- and trillions more in home equity lines of credit and adjustable-rate mortgages -- a cut of the magnitude made Tuesday can translate into billions of dollars in spending power.

"It's bad for seniors who are living on fixed incomes, but this gigantic baby boom generation is largely made up of borrowers," said Gary Schlossberg, senior economist with Wells Fargo Capital Markets in San Francisco.

Wendy and Nicholas Stanton, who work in the entertainment industry, are among the borrowers, with an $83,000 equity line of credit secured by their house in Pasadena.

If the rate on their credit line drops by the same amount the Fed cut its key short-term rate -- three-quarters of a point -- it will shave $50 or so off the line's monthly payment.

The Stantons say they'll spend that money, which is what the central bank wants them to do.

"The way our industry and the housing market are at this moment in time, even a $5 payment cut is significant to us," said Wendy Stanton, an art director out of work because of the writers strike.

The nation's 75 million homeowners are likely to feel the most significant and immediate benefits. Home equity lines of credit are often tied to the prime rate and other short-term indexes that fall in lock step when the Federal Reserve cuts its benchmark rate.

And conventional mortgage rates tend to follow rates on long-term Treasury bonds, which fell further Tuesday after the Fed acted. Already, rates on 30-year fixed mortgages are at their lowest levels in at least 2 1/2 years.

Last Friday, the best rate available on a 30-year loan was 5.5%, said Jeff Lazerson, president of Mortgage Grader, a Web-based loan shopping service. By Tuesday afternoon, it had fallen to 5.125% for borrowers willing to pay 1 percentage point in upfront costs.

That's likely to touch off a refinancing boom, he said.

"For six months, you could have shot a cannon through here and not hit anyone," he said. "Today, the phones lit up like we were having an electrical storm."

What's more, $25 billion to $30 billion in adjustable-rate mortgages are "repricing" each month throughout 2008, said Greg McBride, financial analyst with BankRate.com. Because these loans typically adjust once or twice a year, Tuesday's rate cut combines with other recent Fed cuts to provide many of the borrowers with a huge break.

"This is going to save a lot of people from completely unmanageable payment increases," McBride said. Someone with a $200,000 ARM would have been hit with a $370-a-month payment increase had the Fed not acted in recent months to cut short-term rates a total of 1 3/4 percentage points, he said. Now the hike will probably be in the range of $100 a month.

"For many homeowners, those manageable rate resets will be the difference between keeping a home or losing it," he said.

McBride said the rate cut could prove far more significant than the lending industry's pledge to help certain sub-prime borrowers.

"This affects everyone," he said.

Because the vast majority of credit cards are issued at variable interest rates, credit card debtors stand to benefit too. The latest cut in the Fed's key rate will probably be passed on to consumers within one to three billing cycles, said Justin McHenry, research director at Index Credit Cards.com in Cleveland.

A person with $5,000 in credit card debt will save about $3 a month, according to Bill Hardekopf, chief executive of LowCards.com. That's chump change, to be sure, but for those with big balances it may be enough to help them meet minimum monthly payments and start whittling down their obligations.

Eventually, even the cost of car loans may edge lower, though those rates tend to be stickier, moving far more slowly than the rates on debts that are directly tied to prime or Treasury-rate indexes.

For all the rejoicing among the indebted, there was sorrow among the ranks of savers.

Rates on money market accounts and certificates of deposit have been dropping in recent weeks, said Ray Montague, manager of deposit research at Informa Research Services in Calabasas. And they'll be dropping more within days. Several banks said their money market rates would come down as of midnight Tuesday, Montague said.

In Arcadia, Lonell Spencer, a 79-year-old retired machinist who has tens of thousands of dollars in CDs, braced to lose hundreds a month in interest.

"We don't have an opulent lifestyle as it is," he said. "This is going to make a difference."

David Jones, president of the Assn. of Independent Consumer Credit Counseling Agencies in Orlando, Fla., saw both bad and good in the Fed's move. Jones helps highly indebted borrowers get back on their feet, and lower interest rates are good for them. At the same time, he couldn't help feeling a little sorry for himself.

"I have certificates of deposit," he said. "Some of them are locked in, but the newer CDs are going to be at lower rates. And the amounts I get on my savings and checking account, which are really low, are going to go even lower."

--

kathy.kristof@latimes.com

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