What the Rate Cut Means for Consumers

In an attempt to reignite the economy, the Federal Reserve joined central banks across the globe in a coordinated rate cut that slashed short-term interest rates by up to 50 basis points Wednesday morning.

The move, which puts the U.S. federal funds rate at 1.5%, marks the eighth cut by the Federal Reserve since September 2007. "The outlook for economic growth has worsened and...the downside risks to growth have increased," said Fed Chairman Ben Bernanke Tuesday in a speech to the National Association of Business Economics.

Unfortunately, this rate cut, may not be a cure-all the economy requires."There are all sorts of forces right now that are moving in various ways and it's a very complex environment to be able to forecast how [the rate cut is] going to impact consumers," says Robert Dye, senior economist with PNC Financial Services Group.

In fact, given all the forces at play in the markets today, including the housing downturn and credit crunch, there's a chance few consumers may actually benefit. From mortgages and home equity loans to credit cards and money-market accounts, we take a look at what the rate cut means for consumers:

Mortgages

Thanks to the housing meltdown, mortgage rates are at roughly the same levels they were when the Fed began cutting rates last September. Declining home prices, rising foreclosure rates and a low "investor appetite" for mortgages, among other factors, have kept mortgage rates from heading lower, says Keith Gumbinger, a vice president of HSH Associates, a mortgage-information firm.

Fixed Rate Mortgages
Consumers who have fixed-rate mortgages won't see any changes to their loan's interest rates, says Gumbinger. And the chances of rates on new fixed-rate mortgages falling are slim, he says. The reason? Fixed-rate mortgages are influenced by the 10-year Treasury, and they are largely dependent on long-term economic expectations, rather than short-term interest rates such as the fed funds rate.

"To expect a substantial decline in mortgage rates is really kind of asking for the moon," says Gumbinger.

Last week, rates on a 30-year conforming fixed-rate mortgage averaged 6.23%, slightly lower than the average 6.43% being charged about a year ago.

Adjustable-Rate Mortgages
The Fed's move could place some downward pressure on rates for ARMs, but it won't be as big as a half-point drop, says Gumbinger. Since rates on some Treasurys are falling, borrowers whose ARM rates are pegged to Treasurys may see a rate decrease, says Dye. While those who hold ARMs with rates pegged to the London Interbank Offered Rate (LIBOR) may see an increase since the LIBOR, which is the rate financial institutions use when lending money to one another, is on the rise.

The 5/1 conforming ARM (a mortgage that holds a set interest rate for the first five years and adjusts annually thereafter), currently carries a 6.22% rate. Around this time last year, it was at 6.29%.

Home Equity Loans and Lines of Credit

Unfortunately, homeowners with home equity loans (HELs), which carry a fixed rate, won't see a change in their payments. In fact, as the housing meltdown worsens, interest rates on new HELs are rising, says Gumbinger. The current average rate is 8.17%, up from 7.65 % six months ago.

The variable rates on home equity lines of credit (HELOC), on the other hand, move in tandem with the prime rate and therefore should fall by up to half a percent, says Gumbinger. (When the federal funds rate get slashed, financial institutions often follow with a reduction in their prime rate, which is the rate at which they lend to customers.) Homeowners should see lower rates in one to three billing cycles and new borrowers should see a drop immediately, he says.

Credit Cards

Interest rates on most credit cards are pegged to the prime rate. However, given the cumulative impact of rate cuts over the past year, "there's not a great windfall for credit-card holders," says Greg McBride, senior financial analyst at Bankrate.com.

More credit cards are hitting their floor rates, which means some of them won't be able to lower interest rates anymore -- regardless of additional Fed cuts, he says.

CDs, Money-Market Accounts

Since April, when the last Fed cut occurred, banks have offered relatively high interest rates on certificate of deposits (CDs) and money-market accounts as a way to bring in additional funds, says McBride. That will start to change quickly.

"Over the next couple of weeks you'll see CD yields unwinding," he says.

Of course, those who have money locked into a CD right now won't be affected. Those who want to stash money in a CD, on the other hand, need to act fast before the new rates go into effect, says McBride. Given the liquidity of money market accounts, most existing and new account holders, should expect to see interest rates drop by half a percentage point, he says. Rate changes in CDs and money-market accounts will occur within the next few weeks, he says.

Rates on six-month and one-year CDs currently average 2.1% and 2.47%, respectively, according to Bankrate.com. Rates on money-market accounts average 0.7%.

Money-Market Funds

Taxable money-market funds will experience a decrease in their yield as a direct result of Fed's cut. Yields on most of these funds will gradually drop from 2% beginning Thursday and reach 1.5% in a little over a month, says Peter Crane, president of Crane Data a money market and mutual fund information company. (Some are already below 2%, says Connie Bugbee, managing editor at iMoneyNet.)  As a result, investors will earn less.

One way to avoid this hit is to invest in a tax-free money-market fund, which holds municipal securities whose yields are often pegged to the LIBOR or the Securities Industry and Financial Markets Association (SIFMA) municipal swap index, says Bugbee. Those funds' yields have been increasing and are in the high 5% range, she says.