Some borrowers left out in the cold from rate cuts

The Federal Reserve has lowered interest rates for the sixth time since September, but the campaign is helping only some borrowers.

Rates on home-equity lines of credit, credit cards and auto loans have dropped, and millions of homeowners will avoid paying more as their adjustable-rate mortgages reset.

But for new-home buyers and those looking to refinance, the Fed's rate-cutting campaign has provided little relief.

Rates on 30-year mortgages fell to about 5.75 percent earlier this week, amid anticipation that the Fed would slash its key federal-funds rate by a full percentage point.

After the Fed instead cut rates by three-quarters of a point, rates on 30-year mortgages bounced back to about 6 percent for some lenders. That's only about a quarter-percentage point lower than in September, even though the federal-funds rate has fallen three percentage points since then.

What's up? Blame the investors who buy packages of mortgages on Wall Street.

Burned by the subprime-lending scandal and a rising level of defaults, these investors — which include pension funds, insurance companies and bond mutual funds — are demanding a greater premium for mortgages over risk-free investments such as U.S. Treasury bills. That's a big change from recent years, when investors viewed mortgages as a generally low-risk product.

If the mortgage market were functioning normally, rates would be closer to 5 percent range for a 30-year mortgage, says Frank Trotter, president of EverBank Direct, which originates mortgages.

Mortgage rates typically follow the 10-year Treasury and have historically traded at about 1.8 percentage points above the 10-year Treasury yield, currently about 3.45 percent.

The best strategy for homebuyers:

• Comparison shop. Mortgages aren't all priced alike. Some banks keep the mortgages they write on their books; others sell them on Wall Street (as long as investors are buying). And investors' fickleness these days can whipsaw rates.

• Act quickly. Daniel Schwartz, of Marina del Rey, Calif., took advantage of a brief dip in rates earlier this year and refinanced his 30-year fixed-rate mortgage at 5.125 percent, down from 5.875 percent, resulting in a savings of about $150 to $200 a month. While the 31-year-old computer analyst was able to nail that rate, by the time he told his friends, he says, it was gone.

"Most people haven't been able to get a good rate on a mortgage even though the Fed has been cutting rates," Schwartz says.

Consider how erratic adjustable-rate mortgages have been acting in recent weeks. So-called 5/1 ARMs — with rates that are set for five years and adjust annually thereafter — plunged in late January to 5.26 percent, down nearly a full percentage point from mid-December. On Tuesday morning, however, ARM rates surged to 6.75 percent.

The reason?

"Several lenders were liquidating their ARM portfolios to raise cash," says Michael Menatian, president of Sanborn Mortgage in West Hartford, Conn.

To entice investors, newly issued ARMs must sport higher rates.

Homebuyers who can afford higher payments might consider a mortgage with a shorter payment schedule. One of the effects of the current credit crisis is that mortgage investors are keen on buying 15-year mortgages.

"They perform better in terms of delinquencies," Menatian says. "The borrowers are a better risk, and the mortgages aren't refinanced as quickly."

Menatian says his firm locked in more than 20 mortgages between Monday night and Tuesday afternoon, "and every single one of them was a 15-year."

Even in areas where rates are falling, such as loans tied to the prime rate, the credit crunch is making it tougher for consumers to take advantage.

Rates on home-equity lines of credit have dropped to 6.27 percent from 8.25 percent since September, according to Bankrate.com.

Partly because of lower rates, homeowners have borrowed slightly more against their lines of credit in the fourth quarter of 2007 — the first such rise since early 2005, according to data from Equifax and Moody's Economy.com.

Rates on home-equity lines of credit should fall farther after the Fed's latest cuts, but it might be less than it ordinarily would be because some banks make these loans harder to get.

In recent months, Countrywide Financial, Washington Mutual and others have reduced or frozen the amount of credit available to certain borrowers to protect themselves against falling home values and rising delinquencies.

Banks are expected to post a jump in losses from home-equity loans amid a rise in delinquencies. About 4.7 percent of fixed-rate home-equity loans were delinquent in the fourth quarter of 2007, up from 3.1 percent from a year earlier, and 2 percent of home-equity lines were delinquent, up from 1.1 percent, according to Equifax and Economy.com.

Indeed, mortgage brokers say customers are having a harder time borrowing against the equity in their homes. "We're seeing a lot of lenders freezing whatever is outstanding," says Mitch Ohlbaum, a mortgage broker with Legend Mortgage in Los Angeles.

Some clients, worried about getting cut off from existing lines of credit, have started drawing down their lines in a pre-emptive move, Ohlbaum says. "They're putting the money into savings accounts and CDs because they're afraid they're going to lose access to the funds," he says. "It's their safety net."