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Loans, savings and the Fed cut

Borrowers may bear a lighter interest burden, but deposit yields may not fall quickly.

October 30, 2008|Tom Petruno | Petruno is a Times staff writer.

The Federal Reserve's interest-rate cut Wednesday -- the second in three weeks -- will lower the financial burden of many consumer and small-business borrowers.

Savers, meanwhile, stand to earn less on their bank deposits and on money market mutual funds, although the timing of a significant drop in yields on those accounts is less certain than usual.

Here's a look at some of the effects of the Fed's cut in its benchmark rate to a four-year low of 1% from 1.5%:

* Consumer and small-business loans: Because banks typically lower their prime lending rates in tandem with Fed rate reductions, many floating-rate loans pegged to the prime should drop by half a percentage point as well, matching the Fed's cut.

That will affect the "large amounts of household and business debts [that] are tied to the prime rate," said Tony Crescenzi, bond market strategist at Miller, Tabak & Co. in New York.

Consumers with home equity credit lines that are linked to the prime will see a drop in interest costs, for example.

Bank of America, JPMorgan Chase and City National Bank were among lenders that cut their prime rates to 4% Wednesday, from 4.5%.

Banks had just sliced the prime to 4.5% from 5% on Oct. 8, the date of the Fed's last half-point cut in its key rate -- a move synchronized with other major central banks worldwide in a bid to halt the meltdown in global financial markets.

Some credit card rates tied to the prime also may drop. But check the fine print of your card plan. Some banks put a floor under card rates so that borrowers won't get relief beyond that rate level.

* Mortgages: The Fed's key rate is a short-term rate -- the central bank's target for what banks should charge each other for overnight loans. It doesn't directly affect long-term rates, such as those for conventional mortgages.

But by reducing short-term rates, the Fed and other central banks worldwide are trying to ease the global credit crunch, which could eventually bring down all interest rates.

There's a catch, however. Conventional home loan rates tend to follow the yield on the 10-year U.S. Treasury note.

When fearful investors were rushing into Treasury securities in recent weeks, they drove the 10-year T-note as low as 3.39%. It has since rebounded to 3.87% on Wednesday, with investors' jitters soothed.

The upheaval in financial markets also has made mortgage rates swing wildly.

The average 30-year home loan rate nationwide was 6.04% last week, according to mortgage giant Freddie Mac. That was down from 6.46% the previous week, but up from 5.94% two weeks earlier.

Some adjustable-rate mortgage borrowers are getting help as the Fed and other central banks work to unfreeze credit. Their efforts have helped to pull down so-called Libor rates (which stands for London interbank offered rates) in recent weeks.

Libor is a benchmark for many adjustable-rate mortgages

The six-month dollar Libor rate was 3.43% on Wednesday, the lowest since Sept. 22 and down from a peak of 4.39% on Oct. 10.

* Money market mutual funds: Yields on money market funds used to move in line with Fed changes because a shift in the Fed's rate would directly affect yields on the short-term corporate and government IOUs such funds buy.

But the credit crisis has upended the money markets. Even before the Fed's half-point rate cut on Oct. 8, money fund yields had tumbled in September because of the plunge in Treasury bill yields, as safety-seeking investors rushed into those securities.

By contrast, the average annualized yield on money funds has edged higher since Oct. 8, from 1.47% then to 1.54% this week, according to iMoneyNet Inc.

In part, that's because T-bill yields have rebounded somewhat.

Still, the Fed is trying to bring down rates on other short-term IOUs, such as corporate commercial paper. The central bank began buying commercial paper this week for its own portfolio.

Connie Bugbee, managing editor of iMoneyNet in Westborough, Mass., said money fund investors should expect their yields to drop further in coming months, given the Fed's latest rate cut.

She noted that the last time the Fed's rate was 1%, in 2003-04, money fund yields bottomed at 0.51% on average.

* Bank savings certificates: The good news for savers is that many banks aren't in a hurry to cut deposit rates, because it's cheaper for them to lure consumers' dollars than fund themselves from other sources.

Since the last half-point Fed rate cut on Oct. 8, the average yield on six-month CDs nationwide has edged down just 0.02 of a point, to 2.31% from 2.33%, according to Informa Research Services in Calabasas.

"You're not going to see CD yields tumbling off a cliff" because of the latest Fed cut, said Greg McBride, senior analyst at Bankrate Inc. in North Palm Beach, Fla.

Even so, if you can afford to lock up some of your savings for six months to a year, you may earn significantly more than what you'd end up getting from a money market fund or bank money market account over the same period -- especially if the Fed keeps cutting interest rates.

On the Bankrate.com website Wednesday, about 20 banks were offering 4% or higher yields on one-year CDs.

"There are still some good rates to get out there," said Ray Montague, manager of deposit research at Informa.

But "good" is relative, of course. Nobody's getting rich off bank CDs at these yields. If you want safety and security, though, federally insured CDs still offer that -- and at much better yields than what's available on Treasury securities of similar terms.

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tom.petruno@latimes.com

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