Cut may make you winner, loser, both

NEW YORK — Falling interest rates may be a boon to borrowers, but they can be hard on savers and retirees on fixed incomes.

The Federal Reserve's move Tuesday to cut its key short-term interest rate three-quarters of a percentage point to 2.25 percent was designed to spur banks, credit-card issuers and other financial institutions to lower their rates as well.

Here's how borrowers and savers fare in the lower-rate environment.

Q. How does the Fed's action affect the interest rates on consumer products?

A. When the Fed lowers its federal funds rate — the interest banks charge each other on overnight loans — the financial institutions typically pass on the lower rates to borrowers and savers.

Shortly after the Fed acted Tuesday, many of the nation's big banks lowered their prime lending rate to 5.25 percent from 6 percent.

Q. Will consumers see lower rates on their credit cards?

A. Probably, but not yet, said Greg McBride of Bankrate.com.

"Card issuers tend to pass along rate increases more quickly than rate decreases," he said. The lag is typically up to three months, and the reduction may not match the Fed's cut, he added.

The average rate on a variable-rate credit card six months ago was 14 percent; now it's about 12.35 percent.

Another maneuver that can reduce the benefit for consumers is some card issuers switch to fixed rates from variable rates to keep their profits from dropping.

Q. What about mortgage?

A. "The biggest beneficiaries of the repeated rate cuts are homeowners facing resets with adjustable-rate mortgages," McBride said.

That's because the rate on many of these loans is pegged to the rate on the one-year Treasury bill, which tends to drop after Fed rate cuts.

"Last summer, borrowers with an adjustable-rate mortgage pegged to one-year Treasurys could have seen their rate jump by 3 percentage points," McBride said. "Now, borrowers could see their rate decline."

Q. Will fixed-rate mortgages be affected?

A. These loans typically reflect the rate on 10-year Treasury notes, which are most affected by conditions in credit markets and inflationary expectations than by Fed action on short-term rates.

Fixed-rate mortgages are being offered a bit below 6 percent, not much of a drop from the high around 6.8 percent in July, Bankrate.com estimates.

Q. What about homeowners with lines of credit?

A. Borrowers with outstanding lines of credit should see their monthly payments drop as the rate on these loans falls in line with the prime rate, said David Tysk, a senior financial adviser with Ameriprise Financial.

He said a client with a $100,000 outstanding line of credit already has seen a $180 drop in the monthly payment; that could drop another $20 or more after the latest Fed cut.

Q. What about savers?

A. As the Fed has lowered rates, the return on savings accounts and many short-term investments has fallen, too.

The yields on certificates of deposit are down and investment alternatives such as municipal bonds and money-market funds "are not doing well in the current climate," Tysk said.

He said that what a consumer should do depends on the person's short-term needs and comfort level.

One concerned client recently moved a big chunk of his savings to federally insured bank accounts and government securities, Tysk said.

Q. How are retirees and others living on fixed incomes feeling the pinch of lower rates?

A. "If you are a retiree, these are tough times," Tysk said. Returns on savings are down while costs — from gasoline to heating oil, health care and food — are rising.

Retirees, are finding a variety of ways to cope, Tysk said.

Some, he said, have been borrowing, perhaps to pay for a new furnace or car, because a low rate on a loan beats paying tax of 25 percent or more on a withdrawal from an individual retirement accounts (IRA) or a company-sponsored retirement savings plan.

"They also have an incredible ability to adapt ... delaying purchases, home projects, things like that," Tysk said.

Q. Is the Fed finished?

A. Mark Vitner, Wachovia senior economist, believes there's room for further rate cuts. "They probably have to overdo it, and then take some back later in the year or next year."

He described the Fed action to date as "a full frontal assault on the credit crunch."

"They're hitting with everything they've got. It's pretty remarkable," Vitner said. "I think six months from now we'll look back and marvel at how creative the Fed was and how successful they were."