Consumer Loans Insulated From Fed Even as Mortgages Rise
Consumers may see “almost no effect” on the costs of credit cards and auto loans because those rates are linked to the target federal funds rate, which the central bank plans to keep near zero until 2015, according to Barry Bosworth, an economist at the Brookings Institution.
A tapering of the Fed’s bond-buying program, which may begin later this year, would affect home mortgages because their rates tend to follow government-debt yields. Mortgage rates have already climbed from historic lows in anticipation of the Fed winding down asset purchases.
“From here on out we’re going to see interest rates go up, and not so gradually on the mortgage rate,” said Bosworth, whose Washington-based research group analyzes national public policy. “That’s not a small thing for consumers. They have benefited a lot as borrowers on the lower rate of interest.”
Global stocks tumbled with bond prices yesterday after Chairman Ben S. Bernanke said the Fed may scale back asset purchases that have bolstered the U.S. economy. The central bank has kept interest rates near zero since December 2008, depressing to record lows borrowing costs on houses to auto loans.
The Fed may this year start reducing its $85 billion monthly bond purchases that have fueled gains in markets globally, and end the program around mid-2014 if the U.S. economy improves, Bernanke told reporters on June 19. The Standard & Poor’s 500 Index (SPX) fell 2.5 percent yesterday to extend its biggest two-day drop since November 2011 and Treasury 10-year note yields, a benchmark for consumer debt, climbed to 2.41 percent after touching an almost two-year high of 2.47 percent.
Fifteen of 19 Fed policy makers expect no increase in the federal funds rate before 2015, according to the June 19 forecasts. In March, 14 policy makers had that expectation.
U.S. mortgage rates have increased 17 percent since the beginning of May and 19 percent from the record low of 3.31 percent reached in November, according to Freddie Mac. At the end of 2007, a year before the Fed began its stimulus program, the average rate was 6.17 percent.
Last week rates fell for the first time in seven weeks, a move that may reverse after the Fed’s latest comments. The average rate for a 30-year fixed mortgage declined to 3.93 percent from 3.98 percent, McLean, Virginia-based Freddie Mac said in a statement.
“Rates are still quite affordable if you can qualify for a mortgage,” said Barry Zigas, director of housing policy at the Washington-based Consumer Federation of America. While rising rates will increase monthly costs for borrowers, the moves so far have been small. The bigger hurdles facing home buyers are stricter lending requirements from banks and competition from all-cash purchasers, Zigas said.
An increase in rates would mean fewer people have incentive to refinance existing home loans after a boom in those transactions, Zigas said.
“The refinance market is drying up,” he said. The share of home-loan applicants seeking to refinance was 69 percent for the week through June 14, down from 76 percent in the beginning of May, when rates hovered near record lows, according to the Washington-based Mortgage Bankers Association.
Credit-card loans may hold relatively steady because they usually are indexed to the prime rate -- which is based on the Fed funds rate -- plus a margin added by the company, said Ben Woolsey, director of marketing and consumer research at CreditCards.com, a subsidiary of North Palm Beach, Florida-based Bankrate Inc. (RATE) The prime rate has been at 3.25 percent since late 2008.
“Anything that’s pegged to prime I don’t see upward pressure coming,” Woolsey said. “I don’t think they’ll be lowering rates, I just don’t think they’ll be raising them for the foreseeable future.”
Credit-card rates have stabilized at a national average of 14.96 percent as of June, about the same as the past two years, Woolsey said.
Holders of variable-rate credit cards will see an increase when short-term interest rates eventually rise, said Linda Sherry, director of national priorities at Consumer Action, a nonprofit advocacy group based in San Francisco.
“I would caution consumers if they do have a variable-rate card to consider paying off their balances, throwing as much money as they can at them each month,” Sherry said. “As opposed to being a sitting duck.”
Consumer credit expanded at a faster pace in April, accelerating to a 4.7 percent annual growth rate from 3.6 percent in March, the Federal Reserve reported on June 7. Revolving loans, which include credit cards, rose at a 1 percent rate. Non-revolving loans, which include student and automobile debt, increased at a 6.4 percent rate, Fed data show.
Car loans also are typically tied to the prime rate and won’t see an increase while the federal funds rate stays near zero, said Greg McBride, senior financial analyst at Bankrate. The average five-year auto loan rate of 4.12 percent is little changed this year, he said. The rate has fluctuated between 4.08 percent and 4.16 percent since early January, according to Bankrate.com.
Once the prime rate does rise, car buyers won’t be the only ones to suffer. People with private student loans may see higher costs if short-term interest rates eventually climb, as their variable rates are pegged to the prime rate as well.
“You could really feel it,” said Sherry of Consumer Action.
Students have turned to private loans because government programs, which usually have better terms, don’t always cover the increasing cost of college. Borrowers have more than $1 trillion in student loans and private debt makes up about 15 percent of the total, according to the Consumer Financial Protection Bureau. Those rates have been as high as 16 percent in recent years, according to the bureau’s website.
The fixed interest on some new federal loans is set to double to 6.8 percent on July 1 if Congress doesn’t extend the current rate. An election-year deal last year froze rates at 3.4 percent for one year on subsidized Stafford loans, which are available to low-income students.
For most consumers, higher rates are no guarantee.
The Fed’s tapering considerations may not pan out because it may be overestimating the strength of the U.S. economy, McBride said. The central bank left unchanged its statement that it plans to hold its target interest rate near zero as long as unemployment remains above 6.5 percent and the outlook for inflation doesn’t exceed 2.5 percent.
“If anything I expect rates to stabilize and perhaps pull back in the weeks ahead as Bernanke’s words fade and economic reality sets in,” McBride said. “This is an economy that is not exactly hitting the cover off the ball.”
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