Where can I get in on this zero-interest action?

John W. Schoen Senior producer • Profile • E-mail

Last week's move by the Federal Reserve to let a key interest rate fall to as low as zero has lots of readers asking: Where can I get some of this zero-percent financing? 

If the prime interest rate is at near zero percent shouldn't my interest go down on my credit cards? The fee is supposed to be "prime plus 5 percent" or 6 percent or whatever percent.
— Carol, Fort Myers, Fla.

The prime rate did indeed drop following the Fed’s announcement last week that it was letting the short-term federal funds rate fall to zero. But that fed funds rate applies only to banks lending money to each other overnight. The prime rate — originally reserved by banks for their best (or “prime”) business customers — is typically about 3 percentage points higher than the Fed funds rate. That "spread" is how banks make their money.

Banks set their prime rate wherever they choose. To stay competitive, most of them closely track moves by the Federal Reserve — but there’s no requirement that they do so. Because many consumer loans are now tied to the prime, some nonbank lenders use the average prime rate as the floor for their loans; the added interest represents their spread. One widely followed benchmark is printed daily in the Wall Street Journal, whose editors say it represents the rate that three-quarters of the nation’s 30 largest banks are charging.

Last week, the prime rate at most banks fell to 3.25 percent from 4.0 percent. (The extra quarter-percentage point represents the upper end of the Fed’s “zero to one-quarter percent” target range for overnight lending.)

So if you’ve got a credit card with an adjustable rate that’s “prime plus 5” you should be paying 8.25 percent interest. If it’s higher, give the card company a call and ask why.

Credit card lenders can — and do — raise the rate they originally agreed to if your credit profile changes. In some cases, card companies have been raising rates and cutting credit limits with little or no notice. Unfortunately, if you read the original terms carefully enough, you will see most credit card issuers have the right to change the terms of your agreement at will. Your recourse is to close the account, which isn’t all that easy if you’re running a high balance.

One more reason to pay the thing down every month.

Now that it is cheaper for banks to borrow short-term money, why don't the banks lower their mortgage interest rates to, say, 3 percent to folks who need a mortgage?
— Grace, Pittsburgh, Penn.

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The reason is that mortgages are long-term loans, not short-term. The short-term rate the Fed typically controls applies on only to the rate banks charge to lend to each other overnight.

So why would a bank lend money overnight in the first place? The reason is that banks have to have a minimum level of reserves on their books — set by the Fed — at the close of business every day. If Bank A makes a few extra loans and its reserves dip below the minimum, it has to borrow a little cash from Bank B that took in a little more in deposits to keep it above that level. The next day, the money moves back to Bank B and Bank A pays a little interest for the use of the money. When you’re moving billions of dollars back and forth, that little interest adds up.

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