For many borrowers, the Federal Reserve's interest rate cuts are losing some of their punch.
While last week's half-point cut in short-term interest rates caused the prime lending rate, which banks charge to their best customers, to fall to a nine-year low, many consumers aren't likely to see all of that reduction passed along to them through lower interest rates on loans and other borrowings.
That's because some types of borrowing don't move step for step with the Fed.
Credit card users who carry a balance on certain variable-rate cards will feel the biggest hit from the rate cuts' diminishing returns. And fixed-rate mortgages, which have hovered around 7 percent for the last few months, could drop a bit more, but not anywhere near a half point.
But the rate cut is good news for consumers with home equity lines of credit that are pegged to the prime rate. Car loans also are heading sharply lower because of the Fed's rate cut. Homeowners with adjustable rate mortgages also are clear winners.
Here's a look at how last week's rate cuts affected consumers.
The rate cut party is over for many credit card users.
While the rate cut will save American card holders about $750 million in interest payments over the next year, the full benefit of the lower rates won't reach many borrowers because their variable-rate cards have rate floors, or minimum interest rates, says Robert B. McKinley, the chief executive officer of CardWeb.com, a credit card information service.
Once you've hit the rate floor that's spelled out in the fine print of your cardholder agreement, your borrowing costs won't go any lower, regardless of what the Fed does.
About a quarter of all variable-rate cards have minimum APRs (annual percentage rates) that have been triggered by previous rate cuts, McKinley says.
The popular GM card, for instance, has a variable rate equal to the prime rate plus 9.99 percentage points. With the prime rate dropping to 6 percent last week, that would equal a variable rate of 15.99 percent for GM Card holders. But that's not to be. The card has a rate floor of 16.9 percent, which kicked in after the Fed's previous rate cut in June.
If you've got a variable-rate card, this is a great time to pull out your cardholder's agreement and find out if you've hit the floor.
Most variable-rate cards charge interest that rises and falls in tandem with a specified index, most often the prime rate, which typically moves in lock-step with the Fed's moves. Since the prime rate has dropped from 9.5 percent at the beginning of this year to 6 percent, variable-rate card holders have been enjoying a bonanza of savings. McKinley estimates that credit card users have saved $7.8 billion, or about $100 per household, in interest charges because of the rate cuts.
But just how much of those savings individual consumers receive depends on the terms of their cards. Most variable-rate cards adjust their rates monthly, which means last week's rate cut will show up in their October bill. About 30 percent adjust rates quarterly, which still means the latest reduction should kick in next month, McKinley says.
But another trend in the credit card industry also is muting the impact of the rate cuts. Consumers have steadily been switching to fixed-rate cards, which are not affected by the ups and down of interest rates unless an issuer decides to reduce rates on its own. McKinley says that's unlikely now that the weakening economy is causing more consumers to file for bankruptcy and increasing credit risks.
About 45 percent of credit cards now carry fixed rates, compared with less than 20 percent three years ago, according to CardWeb.com.
Combine all of those factors, and the average interest rate on credit cards had dropped to 14.98 percent last month, compared with 16.57 percent in December - a decline that was a little more than half the size of the 3 percentage point drop in the prime rate over that period, McKinley says.
So if you've already hit the floor with your card, it might be a good time to shop around for a better deal.
While the Fed's rate cuts get a lot of attention, they don't mean nearly as much to fixed mortgage rates. That's because they tend to closely track long-term interest rates, namely the yield on 10-year Treasury bond, which has dropped by about 8 basis points (0.8 percentage point) since Sept. 11 attacks.
That's helped push rates on 30-year and 15-year mortgages down a bit, but not a whole lot. Rates on 30-year loans fell by an average of 12 basis points last week, while 15-year loans dropped by 18 basis points, according to bankrate.com. With rates slipping under 7 percent on 30-year loans, home buyers already are looking at some of the best rates in years.
"Up until recently, the rate cuts have had hardly any impact on the long term rates," says David J. Hunter, the president of HSBC Mortgage USA. "Now, we're starting to see long term rates inch down."
Don't get greedy and wait to see if rates drop a bit more in the coming weeks, although they could fall further if the fear and uncertainty now gripping investors drives them to the security of Treasuries, which could drive down their yields even more.
Even so, for many borrowers, an eighth of a point move in rates only changes a monthly payment by a few dollars, so it probably won't pay to quibble over a small move in rates, Hunter says.
Likewise, if you're refinancing and you can save a good chunk of money or reduce the term of your loan while keeping the monthly payment roughly the same, locking in now probably makes a lot of sense.
What's more, with the financial markets so volatile, it's also possible that rates could go back up in response to some news event, like a big layoff, an OPEC announcement or a military strike.
"Right now, I would move on the rates, at least to the point of getting your application in," Hunter says. "This is as good as we've seen it since 1998."
Homeowners with adjustable rate mortgages are in for a nice break, since the rate cut, coupled with a flight to safety by skittish investors seeking a safe place to stash their cash for a few months, pushed the yield on one-year Treasury bills down to 3.02 percent from 3.43 percent the week before.
Most adjustable rate mortgages are pegged to the yield on the one-year T-bill, so if your ARM has its annual rate adjustment this week, you'll be in for a nice surprise. And with the economy weak and plenty of uncertainty hovering over the nation's financial markets in the wake of the terrorist attacks, it's unlikely that the Fed will raise rates anytime soon. That should keep ARM rates low or maybe even push them down a bit lower over the next month or so.
That could make an ARM attractive for someone who plans on staying in their house for just a few years, Hunter says. But if you plan on staying in your home for a long time, today's fixed rate loans are probably too attractive to pass up.
"It all depends on how long you're going to be in the house," he says.
Rates on variable-rate home equity lines of credit and fixed-rate home equity loans have dropped to their lowest levels in years, according to Greg McBride, an analyst at Bankrate.com.
Home equity lines of credit typically are pegged to the prime rate, so last week's rate cut shaved 50 basis points off most consumers' rates. But with the closely watched federal funds rate down to 3 percent, the rate-cutting may be coming close to the end, although the weak economy may also prevent the Fed from pushing rates back up again soon.
Existing home equity loans, which charge fixed rates, aren't affected by the rate cuts because borrowers have fixed payments and rates. But rates on new home equity loans, which already had dipped below 9 percent before the latest rate cut, could drop even more.