Saturday, April 28, 2001

Rate cuts a gift for borrowers

But savers reaping lower returns on CDs, money markets

By Jeff McKinney
The Cincinnati Enquirer

        With the Federal Reserve aggressively cutting interest rates, those moves are hitting the pocketbooks of Tristate consumers and businesses - mostly positively overall.

        The Fed has slashed short-term interest rates 2 percentage points since Jan. 1, with a chance for another reduction next month.

        For borrowers, the falling rates are great, with adjustable-rate mortgages, home-equity loans and credit cards offering a better value than just a few months ago.

        But for savers, the news is not as good. Because short-term rates control the direction of things such as certificates of deposit and money-market accounts, those individuals are reaping lower returns on their money.

[photo] Dale Barger, owner of Master Equipment Rental in West Chester Township, said the lower rates have allowed him to increase inventory, hire more sales people and increase cash flow.
(Michael Snyder photo)
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        Still, the Fed's action to jump-start the economy by reducing rates — hoping to spark a soft stock market, lift corporate profits and spur consumer spending — is helping thousands of Tristate consumers save big dollars while allowing U.S. companies a better chance to boost profits.

        Consumers, for the most part, are the biggest winners when the Fed cut rates, said Greg McBride of, an online research firm that tracks interest rates.

        For instance, he said a borrower who took a 30-year, fixed-rate $125,000 mortgage when the average U.S. rate was 8.5 percent can now refinance at an average 7.5 percent.

        He said such a move would save the borrower about $110 in monthly payments, or $39,000 over the life of the loan.

        “For someone who did that six months to a year ago, they could use the savings to pay ahead on the mortgage, invest for retirement or pay or save for a child's education,” he said.

        And there are some benefits for savers, too, despite getting paid lower rates on savings products.

        Consider the idea of diversification. Many have shunned CDs in recent years because of the high-flying stock market.

[photo] Jack Brandenburg of Eastgate switched to a 15-year, fixed-rate mortgage with a 6.75 percent rate. He reduced his interest expense by about $90,000 for the life of the loan. His monthly payment increases by $70.
(Steven M. Herppich photo)
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        But with the recent volatility of stocks and with CD rates hitting a five-year high last summer, Mr. McBride said savers are now more willing to invest in CDs.

        The average yield on a one-year CD in June was 5.56 percent, and that rate hasn't fallen as much as the Fed has cut key rates. It stood at 4.11 percent last week.

        Mr. McBride said that although CD yields have dropped, if the inflation rate shows a similar decline, investors' real return is not significantly reduced.

        “Having a diversified portfolio cushions you from downsides in the market and allows you to still get an attractive rate if you're effectively diversified,” he said.

        To examine how the Fed's action is affecting the Tristate, the Enquirer looked at how falling rates are affecting some individuals:

Cutting the mortgage

        The lower rates prompted Jack Brandenburg of Eastgate to refinance $100,000 left on his 30-year, fixed-rate loan with a 7.58 percent rate.

        By switching to a 15-year, fixed-rate mortgage with a 6.75 percent rate at Fifth Third Bank, Mr. Brandenburg reduced his interest expense by about $90,000 for the life of the loan, and he'll pay off the note much faster.

        He will increase his monthly payment by just $70, he said.

        “It will free up dollars for me to invest in the stock market or to buy another home if I choose to” at the end of the loan, said Mr. Brandenburg, a 40-year-old general contractor. “I invested $2,000 to get rid of 15 years of mortgage payments and not worry about that when I retire.”

Lower prime pays

        For business owner Dale Barger, the Fed action has meant the prime rate has dropped to 7.5 percent from 9.5 percent since January. The prime rate is what banks charge their most creditworthy customers, affecting rates on everything from credit cards to business loans.

        The falling rates have allowed Mr. Barger to increase inventory, hire more sales associates and increase cash flow. His company, Master Equipment Rental and Sales in West Chester, sells and rents Ez-Go Golf Carts and also leases and sells everything from forklifts to evacuators.

        Mr. Barger, who banks with Firstar, said the reduced prime rate will lower his company's annual interest expense to $280,000 to cover the cost of inventory. In comparison, before the Fed's action, his annual interest expense for that inventory was $360,000.

        As a businessman, he also sees how the Fed uses rate cuts to trigger spending in the overall economy. For example, he said, he's noticing companies such as Procter & Gamble, which were hesitant to proceed with major construction projects, are now moving ahead.

        He also said that as Master Equipment increases its inventory, that boosts the number of evacuators and forklifts for manufacturers.

        “Gee, get a lot of U.S. business like mine doing the same thing, that's a pretty huge impact in new business investment,” he said.

Bought jumbo CD

        A sluggish stock market — particularly the past year — prompted retired Cincinnati plumbing contractor Lou Buckreus to shift some of his money from the stock market into certificates of deposit.

        The 77-year-old Monfort Heights resident decided to sell his $160,000 of mutual funds and invest a “substantial part” of his gain in a jumbo CD at Winton Savings and Loan.

        After watching the market tumble in recent months and wanting to reduce the capital-gains tax, Mr. Buckreus decided to diversify his portfolio. The CD will add $550 to his monthly income, which includes Social Security and other CDs and stock investments.

        More important, the move will give Mr. Buckreus peace of mind because he knows he will get a fixed rate of return from an investment that's insured instead of worrying about a volatile market.

        Of course, Mr. Buckreus, who decided to shift from mutual funds to the CD before the Fed started slashing rates in January, probably would have changed his strategy today. For example, he said he likely would have invested in a tax-free bond that offers a 7.5 percent return.

        “Even though CDs are lower because of the declining prime rate, I still feel better having a guaranteed rate of return,” he said.

Credit card break

        Millions of Americans who carry plastic in their wallet could save billions of dollars in interest because of the lower rates.

        The reason: Because short-term interest rates have declined so much since the start of 2001, it's likely that even fixed-rate interest on cards will be lowered, said Robert McKinley, president and chief executive of Inc., which tracks such rates.

        He said that with 80 percent of all credit card debt subject to finance charges and with 50 percent of those charges linked to a variable rate, consumers will save $1.2 billion with the latest Fed cut.

        But Mr. McKinley said cards with fixed rates also drop to remain competitive with variable-rate cards, and that could bring savings of about $3 billion from the Fed's latest cut. Combined with the earlier rate cuts, U.S consumers could save $9 billion in interest charges this year compared to last year, he said. For the average household, the savings will mean about $90 a year.

        Mr. McKinley suggested that consumers consider switching to a variable-rate card to take advantage of this year's rate cut.

        He said issuers adjusting rates quarterly are now passing along previous rate cuts this month. He said the Fed's latest action will affect some credit-card accounts during the May billing cycle, while others will have to wait until July to benefit from the cuts.

        And with the prime rate declining, holders of cards tied to that rate should check with issuers periodically to make sure the reduced rate is applied, said Jim Lucas, education director at Cincinnati Credit Counseling Services Inc. He said it can take some issuers up to 90 days to adjust the rate.

        “It can help reduce your monthly balance, but you really need to check to make sure, and when, it will be applied,” he said.

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