Consumer Loan Rates to Droop
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The decision last week by the Federal Open Market Committee to project low interest rates by an additional year into 2014 is groundbreaking, marking the first time the central bank has projected rate plans that far out.
Why the change? It's part of the Federal Reserve's plan to open up its decision-making process.
"They're trying to increase transparency," says Henning Bohn, economics professor at the University of California, Santa Barbara. "They don't want to let people guess and create uncertainty."
But the Fed also has a more immediate goal of driving down interest rates, including rates on consumer financial products, says Andrew Busch, Chicago-based global currency and public policy strategist at BMO Capital.
"The Fed is playing a game here. It's trying to manipulate the market's expectations," Busch says. "It's trying to generate activity by the market to buy bonds and lower interest rates."
The Fed's move keeps the federal funds rate near zero percent, dating back to December 2008, and it is showing some results in the bond market. Rates on the 10-year Treasury immediately dropped a few basis points.
That should act to lower rates on consumer financial products such as mortgages and auto loans, says Troy Davig, a senior U.S. economist for Barclays Capital based in New York.
To give you an idea of how financial products will be affected, read on.
The Fed and Mortgages
Planning to get a mortgage or take out a home equity loan? Thank the Fed for trying to keep rates low and stable.
The Fed says it will keep the federal funds rate near zero until late 2014. Although the federal funds rate is not directly linked to mortgages, it's a thermometer of the economy. As the economy gets hotter, rates tend to go up.
The economy is anything but hot, according to the Fed's latest forecast, in which it lowered its growth prediction for 2012. Unemployment is expected to remain high through 2013, and inflation is expected to rise slightly. Bad economic news is usually good for rates. The exception is inflation.
"Inflation is awful for mortgage rates, but now there's an inflation 'target,'" says Dan Green of Waterstone Mortgage in Cincinnati. "This will prevent runaway rates like we saw in May 2009. There was a 10-day period over which mortgage rates rose 1.125%."
The Fed's forecast should make rates more stable. But the U.S. economy isn't the only factor behind rates. One major development in Europe is all it takes for rates to shoot up, says Brett Sinnott of CMG Mortgage in San Ramon, Calif.
Fed Drives Down Auto Rates
Thanks in part to the Fed, it's a good time to be in the market for an car loan.
Interest rates on auto loans are at historic lows, with the Bankrate average for a 60-month new car loan bottoming out at 5.22% as of Jan. 25. The Fed's new federal funds rate projection should only help to drive those rates lower, says Paul Taylor, chief economist for the National Auto Dealer Association in McLean,Va.
The Fed's move "affects expectations about the market, so it would follow that it would help keep rates low. So it is helpful," Taylor says.
The Fed's rate-setting power is especially strong for car loans, since they are for shorter terms than other loans, Taylor says. The Fed's announcement means that auto buyers have years of historically low rates ahead of them.
As if that weren't enough to put a smile on a car buyer's face, that dynamic is currently being reinforced by foreign investors seeking safety from economic trouble in Europe.
"The flight to safety there should bring Treasury bond rates lower and therefore short-term interest rates lower," Taylor says. "The outlook for finance for light-vehicle purchases is excellent over a multiyear horizon."
Fed Move Tough on CD Rates
If you heard a faint sigh last Wednesday around 12:15, you may have recognized the sound of savers' faint hopes being deflated.
The pinprick to the proverbial balloon was delivered by Ben Bernanke, chairman of the Federal Reserve, announcing that current economic conditions could warrant exceptionally low interest rates until late 2014.
The result of the central bank's low interest rate policy will be lower rates for CDs, or certificates of deposit, says Dan Geller, executive vice president of Market Rates Insight, a pricing consultant to banks in San Anselmo, Calif.
"The Fed does not see substantial recovery happening very soon. That means that lending, especially mortgages, is not going to increase in the near future and demand for lending is going to remain soft," he says.
In order for banks to attract loans, they need to price them attractively which means lowering interest rates. If banks earn less from loans, the amount they are willing to pay on deposits, including CDs, also must decrease.
With a typical one-year CD yielding about 0.34% as of last Wednesday and a steady downward trend, CD rates amounting to a handful of basis points or less are not too far away.
Card Rates Drag Into 2014
The Fed's forecast to keep a benchmark interest rate near zero for more than two years means cheaper credit card rates.
"I think credit cardholders win," says Bill McCracken, CEO at Synergistics Research Corp., a marketing research firm for financial services in Atlanta. "At worst, issuers will keep rates they charge consumers for their balances about the same."
Credit card rates, especially variable rates, are tied to the prime rate, which typically follows the federal funds rate. The annual percentage rate on variable credit cards was 14.5% this week, while the APR on fixed cards came in at 13.71%, according to Bankrate's latest weekly survey of interest rates.
Any big change in interest rates would come from new regulations that cut into bank profits. Issuers likely would pass on the higher costs to cardholders, McCracken says.
Otherwise, expect much of the same for credit card rates, unless the Fed changes policy should the economy grow faster than expected.