Question: When interest rates fall, who benefits?

A BuyandHolder

Answer:

Dear BuyandHolder,

A most timely question, especially in view of the fact that earlier this week the Federal Reserve Board cut short-term interest rates by a quarter of a percentage point -- to 4.25%. This was the third rate cut by the Fed in a little less than three months.

Why?

The Fed cut rates to encourage spending and borrowing and thus help offset the slump in the housing market and the high cost of energy -- among other things. Although those remain troubled areas of the U.S. economy, keep in mind that unemployment is low and, helped by the weak dollar, sales of U.S. goods abroad have increased dramatically this year.

Adjustable Rate Mortgages

Homeowners with adjustable rate mortgages (ARMs) will benefit from the rate cut, provided their mortgages are tied to the one year Treasury bill. (The Fed rate cut does not help borrowers whose adjustable rate mortgages are linked to the LIBOR index, which is the London Interbank Offered Rate.)

Over the months during which the Fed has recently cut rates (September, October and last Tuesday), yields on one year Treasuries have dropped from about 5% to a little over 3%.

Credit Cards

Credit card holders (with a variable interest rate) are likely to see a small decrease in rates on unpaid balances. There's a caveat, however and that is any rate drop will go only to those who have excellent credit.

The reason why lower rates will apply only to those with good credit is that lenders want to protect their exposure to bad loans.

Note: The standards for getting new credit cards have gradually been tightened and penalty rates for those who are high risk have been increased. Chasing after bad loans (those that do not pay on time or pay not at all) is an expensive proposition for lenders.

Home Equity Lines Of Credit

These loans are tied to short-term rates...so you can expect rates on adjustable home equity lines of credit loans to fall.

If you do not have a loan but are considering one, continually monitor rates and move in when rates drop - within a matter of weeks.

$Tip: The easiest way to track all interest rates is at www.bankrate.com.

The Fed rate cut will not affect existing fixed rate loans.

Other Loans

The Fed's short-term rate cut will eventually be a positive for those considering car, business or personal loans as well as for consumers with excellent credit who are buying a new home, taking out a second mortgage or refinancing.

Not Such Good News For Bank CDs

People who like to put some of their savings in bank certificates of deposit will, of course, see a slight decline in rates. If you're thinking of buying a CD, you would be wise to do so immediately, before the affect of the Fed rate cut takes place.

Good luck!