What the Fed's big rate cut means to you

Wow! Tuesday was like a bungee jump for investors, with stocks plunging at the market opening, recovering and then dipping again before ending the session with modest losses.

If you’ve been investing for 10 to 20 years, you’ve lived through rough spots like the '87 crash and the tech-stock collapse early in this decade, but that doesn’t make this year’s market plunge easy to stomach. With fear of a recession mounting, the Dow Jones industrial average and other key U.S. and foreign-stock indicators have been heading down — way down.

In a highly unusual move, the Federal Reserve on Tuesday slashed the fed funds rate to 3.5 percent, from 4.25 percent, hoping to calm the markets and to stimulate the slowing economy and avert recession. That the Fed did so a week before its scheduled meeting underscores how perilous conditions have become.

So, what does it mean to you?

First, the good news: If you need to borrow money, it might get cheaper. Rates on 30-year, fixed-rate mortgages already have fallen to about 5.4 percent from 6.3 percent six months ago. These rates take their cue from 10-year U.S. Treasury bonds, whose yields have fallen to 3.4 percent from 4 percent at the start of the year, so maybe the 30-year mortgage will fall even further.

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If you are thinking of buying a new home or refinancing a mortgage, consider waiting two or three weeks to see what mortgage rates do. There’s not much risk they’ll go up significantly, and there’s some chance they’ll drift down. Some analysts think the Fed may cut rates again Jan. 30 after next week's two-day meeting.

Adjustable-rate relief?
Homeowners with adjustable-rate mortgages also may benefit from the Fed rate cut, which could lower the indexes used to reset adjustable loans. The one-year Treasury bill, for example, now yields about 3 percent, down from 3.2 percent a month ago and 5 percent a year ago.

In other words, if your loan resets every 12 months and used the one-year Treasury for a reset today, the interest rate could drop by two full percentage points, perhaps saving you hundreds of dollars a month.

Still, you might consider using this opportunity to refinance to a 30-year, fixed-rate loan. You could lock in that unusually good, below-6 percent rate and avoid rate hikes you might face in the future with an adjustable loan.

The general decline in interest rates could influence rates on car loans, credit cards and home-equity loans, but so many factors affect those rates that it’s too soon to know for sure. With interest rates in flux, keep an eye out for good deals.

Of course, lower rates are not so great for people trying to earn interest. But don’t despair — some institutions are still offering healthy rates of 4 to 5 percent on savings accounts and certificates of deposit. That’s because they’re hungry for cash to make loans.

Shop for CDs at Bankrate.com and take a look at the 4 percent savings-account rate at ING Direct and the 5 percent savings at E*Trade. Remember that savings-account rates can change at any time, while CD rates are locked in.

If you are a fixed-income investor looking around for better yields, beware the siren song of junk bonds. Many are showing yields of 10 percent or more, but that’s because high-yield bond prices have fallen as investors worry about default, which is when a bond fails to make the interest and principal payments promised. Defaults tend to rise in recessions. In fact, when falling junk bond prices are taken into account, their owners have lost money this year despite the high yields.

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