What a Fed Move Would Mean for Your Loan Rates

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1 Page 1 of 5 February 10, :10 p.m. EST MONEY What a Fed Move Would Mean for Your Loan Rates Part of Our Series, Dealing with Debt By DEXTER WEBB THE WALL STREET JOURNAL ONLINE February 10, :10 p.m. With interest rates hanging low these last few years, consumers with good credit records have managed to secure loans at decent rates. But now signs suggest 1 that short-term interest rates might start to rise. DOW JONES REPRINTS This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit: See a sample reprint in PDF format. Order a reprint of this article now. The Federal Reserve recently relaxed an earlier commitment to hold interest rates low for a "considerable period," saying instead it can be "patient" in raising rates going forward. The subtle shift in language has led to speculation 2 that the Fed may be considering increasing rates sooner than many expected. Investors will search for clues Wednesday when Fed Chairman Alan Greenspan presents his monetary-policy report to Congress. Any Fed rate increase could have a ripple effect on consumer loan rates. The specific impact depends on the type of loan. While rates on credit cards and home-equity lines of credit tend to move within a month to three months after Fed action, the 30-year fixed-rate mortgages respond to broader economic trends. Here's a look at economic factors that make various consumer loans move, and how rate fluctuations hit your wallet. The numbers don't take into account specifics like the size of your loan, your credit score or deals offered by individual lenders hungry for various kinds of loan business. 30-year fixed-rate mortgage What makes them move: The yield on the 10-year Treasury note, currently about 4.1%, is the benchmark for interest rates on 30-year fixed-rate mortgages. Generally, lenders set their base mortgage rate at a margin to the yield, roughly 1.9 percentage points over the past year, says Doug Duncan, chief economist at the Mortgage Bankers Association. The 10-year Treasury is less responsive to Federal Reserve interest-rate decisions than shorter-term Treasurys are. Inflation and other economic factors play a bigger role, Mr. Duncan says. Holders of longer-term Treasurys are wary of inflation because it erodes the value of their investment. DEALING WITH DEBT: A SERIES The low-inflation environment of the past two years has boosted prices on Treasurys in general, pushing down yields,

2 Page 2 of 5 3 Burdened 4 : Americans overall are crushed with debt. Who's suffering? Fiscally Fit 5 : Guidance for high-income workers struggling under a back-breaking debt load. Losing Control 6 : If you don't plan right, you can end up vulnerable to massive debt and all the miseries that come with it. Especially if you're a two-income family, says "The Two- Income Trap." Fiscally Fit Exchange 7 : Readers share their debt woes. Paying It Down 8 : An interactive worksheet that helps you prepare a debt-payment plan, from Bankrate.com. which move in the opposite direction to prices. Ten-year Treasury yields have fallen from 5.1% in January 2001 to roughly 4.2% at the end of January Over the same period, interest rates on 30-year fixed-rate mortgages have declined from a monthly average of 7.3% to roughly 5.9%, according to HSH Associates, a financial publisher in Butler, N.J. What it means for you: Suppose you're applying for a $200,000 mortgage from a lender that charges a margin of two percentage points above the 10-year Treasury. At a yield of 4%, you'd be charged 6%, resulting in monthly payments of about $1,199. If the 10-year Treasury yield were 5%, however, then you'd be charged 7% for a monthly payment of $1,330. That's roughly $130 more in monthly payments, or $9,360 over six years, about the average length of time homeowners stay in a property. Coming Up This Month: Forget what the brokers say. How much house can you really afford? Terri Cullen helps you find the answer. Creative ways small businesses can collect from delinquent customers, without resorting to court. WSJ columnist Jeff Opdyke, in an excerpt from his new book, "Love & Money," reveals how debt affects how a potential mate may perceive you. * * * Question of the Day 9 : Have you incurred more debt at this point in your life than you expected? Check average interest rates for mortgages and find your best local rates in our rate center 10, from Bankrate.com Adjustable-Rate Mortgage What makes them move: Adjustable-rate mortgages, or ARMs, have a fixed rate for a set number of years, and then the rate adjusts. How often they adjust depends on the particular loan, Mr. Duncan says. Lenders are required by law to cap the overall rate increase over the life of an ARM, according to the Federal Reserve 11. Rates on five-year ARMs are typically tied to yields on two-, three- and five-year Treasurys, says Jeff Speaks, chief economist at Countrywide Financial Corp. Short-term Treasurys are sensitive to the Federal Reserve's action on the federal funds rate, the interest rate banks and other institutions charge each other for overnight loans. That rate currently stands at 1%. In general, Treasurys with shorter maturities are affected fastest and greatest by any Fed move. That doesn't mean, however, that you'll be better off with a loan priced on the five-year Treasury as opposed to one based on the two-year Treasury. As with fixed-rate mortgages, lenders add a margin to whatever reference rate they use. Margins vary by lender, though they tend to be constant over the life of the loan. Mr. Duncan of the Mortgage Bankers Association says it's a good idea to have a sense of how the Treasury on which your loan is based performs in different interest-rate environments. He suggests asking lenders for historical data on whatever benchmark is used to set the interest rate. What it means for you: While ARMs work in much the same way as fixed mortgages, certain ARMs can be a more complicated. In the simplest version, the rates track a benchmark. Say, for example, your five-year ARM is tied to

3 Page 3 of 5 the three-year Treasury, the yield is at 2%, and there's a three percentage point margin. Your monthly payments for the first five years, at 5%, would be $1,074. If the three-year Treasury yield rises to 4% by the sixth year of the loan, the rate would be adjusted to 7% for monthly payments of about $1,298, a difference of $224. With trickier ARMs, the interest rate can increase even when the underlying index declines. This handbook 12 from the Federal Reserve Board explains some of the intricacies of ARMs and ways you can protect yourself. To decide whether an ARM or fixed mortgage is better for you, use our calculator 13, from SmartMoney. What's Rockin' that Rate? Type of Loan Sources: Bankrate.com, Federal Reserve, Wall Street Journal Online research Car Loans What makes them move: Car-loan interest rates are closely tied to changes in the prime interest rate, the rate banks charge to their highest-rated customers. Prime, which currently stands at 4%, is influenced by the Federal Reserve interest-rate decisions. Lenders add a margin to the prime rate. Loan rates are generally fixed. What it means for you: The steep decline in prime lending rates during the past three years offers a good example of how changes in a benchmark can affect loan payments. Assume that a car lender uses a margin of 2% above prime to set base lending rates, and that you qualify for the best rate. If you had applied for a five-year $20,000 car loan back in January 2001, when prime stood at 9.5%, you'd have incurred monthly payments of roughly $440. The same loan taken out today, at 6%, would cost you about $387 a month, saving you $3,180 in payments over the life of the loan. Check out average auto-loan financing rates for your area with tools 14 from our partner, Edmunds.com. Home Equity Lines of Credit/Loans What Makes It Move 30-year fixed-rate mortgage 10-year Treasury, influenced by broad economic trends like inflation Adjustable-rate mortgage Short-term Treasurys, influenced by Federal Reserve policy decisions Home Equity Line of Credit Car loan Credit card Private student loan Federal student loan Short-term Treasurys, influenced by Fed decisions What makes them move: A home equity line of credit (HELOC) is a form of revolving credit based on the prime rate. Although the prime rate changes within a day or so to reflect the Federal Reserve's

4 Page 4 of 5 action, banks generally price these rates monthly or quarterly. That means that if the Fed raises shortterm interest rates, it may be one-to-three months before consumers see a change in their monthly HELOC payments. Most HELOCs are variable-rate loans, and the rate you pay is the sum of the index plus a margin. Monthly payments may fluctuate. Borrowers can tap their line of credit as needed for the term of the loan. The rate on home-equity lines currently average 4.71%, according to Bankrate.com. The average is down from about 10% three years ago. Rates on new home-equity loans, currently at 7.27%, would also likely rise if the Fed increases rates. A home-equity loan is based on a fixed-interest rate with the same payments each month. Unlike a line of credit, it's a one-time lump sum that is paid off over a set period of time. With a home-equity loan, your payment stays the same for the life of your loan. What it means for you: If your HELOC is tied to the prime rate at 4% with a 2 percentage point margin, you'd pay 6%. Assume that you borrow $20,000 under a plan calling for interest-only payments. At a 6% interest rate, your initial monthly payments would be $100. If the rate were to rise over time to 8%, your monthly payments would increase to $133. Most variable-rate lines of credit have a cap to limit how much and how often the rate can change each year. A cap typically keeps the rate from increasing more than two percentage points a year. Check out rates on home-equity loans and lines of credit in our rate center 15 from Bankrate.com. Credit Cards What makes them move: Credit-card issuers use any one of a variety of indexes to set their interest rates, chief among them the prime rate and yields on the one-, three- and six-month Treasurys. Whatever the index used, in general credit-cards rates move with changes in short-term interest rates, which are influenced by Fed decisions. What it means for you: Credit cards with variable interest rates are most likely to be directly affected by changes in the index to which they are tied. For example, if prime were to rise to 8% from its current 4%, the rates on cards with variable interest rates tied to prime would also increase. Creditcard companies generally adjust rates on either a monthly or quarterly basis, says Daniel Ray, editor in chief of Bankrate.com 16. Say, for example, you had a credit card with a $2,000 balance that you wanted to pay off in 12 months. The card's rate is set at 10 percentage points above prime. If prime jumped from 4% to 8%, you'd have to increase your monthly payments to $183 from $178 to pay off the balance on schedule. Card issuers may also adjust rates on cards with fixed interest rates in response to changes in a respective index, though the issuer must inform you of the change. Check average interest rates for credit cards at our rate center 17 from Bankrate.com. Student loans What makes them move: Generally, rates on private education loans are tied to the prime rate. Rates on federal education loans, such as those available under the Stafford loan program, are set annually on July 1 each year at a margin to the closing price of the 91-day Treasury bill. Interest rates on

5 Page 5 of 5 student loans are fixed over the life of the loan. However, you can consolidate outstanding loans a single time, locking in a lower rate and also extending the repayment terms. What it means for you: Suppose you received a $20,000 private loan in September 2003 to fund your M.B.A. studies, and qualified for the then-prime rate of 4%. Assume that you spend 21 months in school and then have a six-month grace period before a 180-month repayment term kicks in. In this scenario, your monthly payments would be roughly $167, according to figures provided by SLM Corp, commonly known as Sallie Mae, a provider of federally guaranteed student loans. The same loan taken when prime is one percentage-point higher, or 5%, would result in monthly payments of about $175. If prime were to climb to 6%, payments would increase to $197. Write to Dexter Webb at dexter.webb@wsj.com 18 --Alexandra Kaptik contributed to this article. URL for this article: Hyperlinks in this Article: (1) (2) (3) (4) (5) (6) (7) (8) prodtype=loan (9) (11) (12) (13) (14) (15) (16) (17) (18) mailto:dexter.webb@wsj.com Copyright 2005 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at or visit

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