Meaning of Low Long-Term Fed Rates

Federal Reserve chairman Ben Bernanke has decided to provide more transparency in Fed decisions by announcing the long-term plan to keep interest rates low until 2014. Knowing ahead …

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Federal Reserve chairman Ben Bernanke has decided to provide more transparency in Fed decisions by announcing the long-term plan to keep interest rates low until 2014. Knowing ahead of time that rates won’t rise has an impact on several different areas for the everyday consumer and investor. A few examples include how people may choose to save money, what kind of mortgage to contract and whether to take a home equity loan. For example, the announcement of low rates have made money-market accounts and CDs all but useless due to low investment earnings, while more people may consider adjustable-rate mortgages knowing the rates are likely to stay low. For more on this continue reading the following article from TheStreet.

My, how things have changed. In the old Alan Greenspan days, the Federal Reserve’s plans for interest rates were a mystery enveloped in a fog. Now, under Ben Bernanke, the Fed has become so open that it has already announced plans to keep rates low through late 2014.

And while transparency is generally a good thing, the fallout from the Fed’s new disclosures will affect financial products in a variety of ways. Here are some implications:

Savings
In recent months savings rates have been so low there was little benefit in tying money up for a year or longer, as extra earnings from the longer commitment were offset by the risk the investor would miss a chance to invest at a higher yield in a few months, since it was more likely yields would rise than fall. Not to mention the fact that such low yields meant the money would not even beat inflation over time.

Now that the Fed announcement makes the odds of higher yields low to non-existent, tying up cash that could pay. Currently, the average money-market account yields a paltry 0.162%, while two-year certificates of deposit pay nearly 0.52%, three times as much. Granted, that 24-month yield is still pretty low, but why not get it if there’s no downside? Just be sure to investigate the CD’s early withdrawal penalty, in case yields jump unexpectedly and you want to move your money to a higher rate.

Adjustable-rate mortgages
Most mortgage shoppers will be wise to take out fixed-rate loans to lock in today’s extraordinarily low rates, such as the 4% offered by the best 30-year deals, but two groups might consider ARMs since rates are unlikely to rise in the next couple of annual resets.

Homeowners who already have ARMs should consider sticking with them a little longer rather than refinancing to fixed-rate loans. Because ARM resets are governed by short-term rates, many of these loans are now charging a scant 3%, so refinancing to a fixed loan at 4% would raise payments by around one-third. Waiting to refinance, though, means possibly missing the opportunity get today’s low fixed rate, so the borrower should watch trends carefully and be ready to refinance to a fixed deal on short notice.

Homebuyers who don’t expect to stay in the house for the long term might also gamble on ARMs in hopes rates will stay low. Five- and seven-year ARMs are especially attractive, with starting rates well below 3%.

Home equity loans
Jittery lenders have made it pretty tough to get a home equity loan, but the deals are good for those who have enough equity and good credit to qualify.

Generally, long-term borrowers of large sums are better off with installment loans, which charge a fixed rate for five, 10 or 20 years. Currently, installment loans for 10 years or less average below 7%, which is quite attractive.

But if the Fed will keep short-term rates low for the next couple of years, a home equity line of credit is worth a look. After the first few months, HELOC rates float with market conditions, so borrowers face the risk of higher payments over time. The Fed’s plan diminishes that risk considerably.

Many HELOCs now start at 3% to 3.5%. After that, they adjust by adding a margin to the prime rate, which is currently 3.25%. A borrower with good credit can get a two-point margin, for a loan rate of 5.25%.

HELOCs are best for borrowers who will be able to pay off their balances on short notice if rates rise.

This article was republished with permission from TheStreet.

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