Q&A on the Fed’s decision to cut rates

updated 9:14 a.m. ET March 19, 2008

NEW YORK - Falling interest rates may be a boon to borrowers, but they can be hard on savers and retirees on fixed incomes.

The Federal Reserve on Tuesday cut its key short-term interest rate three-quarters of a percentage point to 2.25 percent — a move designed to spur banks, credit card issuers and other financial institutions to lower their rates as well.

It was the sixth cut since September, and it pushed the rate a full 3 percentage points below the 5.25 percent that prevailed last summer.

Here’s how borrowers and savers are faring in the lower-rate environment.

Q: How does the Federal Reserve action affect the interest rates on consumer products?

A: When the Fed lowers its federal funds rate, which is the interest banks charge each other on overnight loans, the financial institutions typically pass on the lower rates to borrowers and savers. Shortly after the Fed acted, many of the nation’s big banks lowered their prime lending rate to 5.25 percent from 6 percent.

Q: Will consumers see lower rates on their credit cards?

A: Probably, but not right away, said Greg McBride, senior financial analyst with Bankrate.com.

“Card issuers tend to pass along rate increases more quickly than rate decreases,” he said. The lag is typically up to three months, and the reduction may not match the Fed’s cut, he added.

The average rate on a variable-rate credit card six months ago was 14 percent; now it’s about 12.35 percent.

Another maneuver that can reduce the benefit for consumers is that some card issuers switch to fixed rates from variable rates to keep their profits from dropping.

Q: What about home mortgage loans?

A: “The biggest beneficiaries of the repeated rate cuts are homeowners facing resets with adjustable-rate mortgages,” McBride said.

That’s because the rate on many of these home loans is pegged to the rate on the one-year Treasury bill, which tends to move down after Fed rate cuts.

“Last summer, borrowers with an adjustable-rate mortgage pegged to one-year Treasuries could have seen their rate jump by 3 percentage points,” McBride said. “Now, borrowers could see their rate decline.”

So a family with a $200,000 home loan would have seen a $370 increase in monthly payments if the rate adjusted last summer, but a loan that reset this spring would have a $50 per month decline, he said.

Q: Will fixed-rate mortgages be affected?

A: These loans typically reflect the rate on 10-year Treasury notes, and this is affected more by conditions in credit markets and inflationary expectations than by Fed action on short-term rates. Fixed-rate mortgages currently are being offered a bit below 6 percent now, not much of a drop from the high around 6.8 percent last July, Bankrate.com estimates.

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