What the Fed's Moves Will Mean to Your Loan
The good news: The economic recovery is strong enough that the Federal Reserve will likely raise rates.
The bad news: A variety of consumer loans, from auto loans to 30-year fixed-rate mortgages, will become more expensive. This week, for the first time in 15 months, the Federal Open Market Committee shifted its assessment of the economy, saying the risk of economic weakness was balanced against the risk of inflation. After 11 rate cuts, this prompts the question of when rates will start to rise -- many think it could come on May 7, at the next Fed meeting. Indeed, the federal funds futures market put the odds of a quarter-point hike in May at 78%. "I don't think we'll see 11 Fed moves this year, but a hike may happen in June," says D.C. Aiken, senior vice president at mortgage lender Homebanc. Signs of inflation and a more robust than expected economic recovery could push the Fed to take strong action to manage economic risks, he says. As a result, short-term interest rates will rise, taking other rates with it. The Fed has direct control over two rates: the federal funds rate, or the overnight lending rate banks charge each other, and the discount rate, or the overnight lending rate the Fed charges banks. As a result, Fed moves greatly affect short-term rates, which can directly affect some, but not all, consumer loans -- a discrepancy that can confuse consumers.| A Rising Tide ... Rates are expected to lift across the board |
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| Product | Current Rate | End-of-Year Prediction | |
| 30-year fixed-rate mortgage | 7.06% | 7.75-8.0% | |
| 15-year fixed-rate mortgage | 6.55 | 7.5-7.75 | |
| One-year ARM | 5.49 | 6.3 | |
| Home equity line of credit | 5.2 | 7.5 | |
| Credit card rate, national average | 13.05 | 15.0-15.5 | |
| Auto loans | 8.41 | 9.25 | |
| One-year CD | 2.12 | 3.25 | |
| Five-year CD | 4.3 | 5.5 | |
| Source: Greg McBride, Bankrate.com | |||
Breaking It Down
"People tend to think that when the Fed cuts rates, mortgage rates are going to fall," says Doug Duncan, chief economist for the Mortgage Bankers Association of America. But in actuality, he says, the Fed has little effect on a 30-year fixed-rate mortgage, because rates on longer-term loans rise and fall with perceived inflation risk. The 10-year Treasury yield is an excellent barometer of this risk, he says, making its movement a good way to gauge mortgage rates.| Treasury Yields Fell as the Fed Cut ... | |||
| Treasury | Yield on March 19, 2001 | Yield on Sept. 19, 2001 | |
| One-year | 4.24% | 2.46% | |
| Five-year | 4.53 | 3.81 | |
| Seven-year | 4.29 | 2.81 | |
| 10-year | 4.81 | 4.77 | |
| Source: Baseline | |||
| ... But Are Rising as the Recovery Takes Hold | |||
| Treasury | Yield on February 19, 2002 | Yield on March 19, 2002 | |
| One-year | 2.06% | 2.52% | |
| Five-year | 4.19 | 4.71 | |
| Seven-year | 2.93 | 3.57 | |
| 10-year | 4.87 | 5.33 | |
| Source: Baseline | |||
Plastic, Rubber and Chrome
Not only are home loans getting pricier, but credit card rates also could skyrocket this year. Like home equity lines of credit, credit cards are tied to the prime rate, but they tack on a hefty premium because they take on additional risk by lending without collateral. According to Bankrate.com, the current national average credit card rate is 13.05%, but by the end of 2002, McBride says, rates could jump to 15.5% "if the Fed were particularly active." In the next few months, credit card rates won't move much but will rise sharply as soon as the Fed hikes. "There's a strong correlation between the Fed and credit cards," he says. Automobile loans, also priced to the prime rate, should move from 8.41% to 9.25% by year's end, McBride says.A Silver Lining
While loans will be more expensive, savings will earn more. After falling sharply due to 11 straight cuts from the Fed, rates on certificates of deposit, or CDs, will slowly come back. As the Fed cuts short-term rates, CD rates fall quickly as bankers try to keep pace with the moves and keep turning a profit. But when the Fed begins to raise rates, bankers feel no pressure to pay CD holders higher rates, raising rates slowly and reaping the profits. As a result, McBride predicts five-year CDs will yield 5.5% by year-end, while the one-year will yield 3.25%. In the fall of 2000, a five-year CD yielded 6.2%, a five-year high, but it now sits at 4.3%. The one-year CD hit 5.67% in fall 2000, also a five-year high, but now yields only 2.12%. "They'll move higher this year, but probably not back to those five-year highs," McBride says.- Loading Comments...
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