How the Fed’s cut will filter down to borrowers, savers

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After the Federal Reserve’s latest half-point interest rate cut on Wednesday (to 1% for its benchmark rate), here’s the CliffsNotes summary of the real-world effects for borrowers and savers:

--- Consumer and small-business loans: Because banks typically lower their prime lending rates in tandem with Fed rate reductions, many floating-rate loans pegged to the prime -- such as home-equity credit lines -- should drop by half a percentage point as well, matching the Fed’s cut.

Bank of America, JPMorgan Chase and City National Bank were among lenders that cut their prime rates to 4% Wednesday, from 4.5%.

Some credit card rates tied to the prime also may drop. But check the fine print of your card plan: Some banks put a floor under card rates, so that borrowers won’t get relief beyond that rate level.

--- Mortgages: The Fed’s key rate is a short-term rate. It doesn’t directly affect long-term rates, such as for conventional mortgages. But by reducing short-term rates, the Fed and other central banks worldwide are trying to ease the global credit crunch, which could eventually bring down all interest rates.

There’s a catch, however: Conventional home loan rates tend to follow the yield on the 10-year U.S. Treasury note. When fearful investors were rushing into Treasury securities in recent weeks, they drove the 10-year T-note as low as 3.39%. It has since rebounded to 3.87% as of Wednesday, as investors’ jitters have lessened.

The upheaval in financial markets also has made mortgage rates swing wildly. The average 30-year home loan rate nationwide was 6.04% last week, according to mortgage giant Freddie Mac. That was down from 6.46% the previous week, but up from 5.94% two weeks earlier.

Some adjustable-rate mortgage borrowers are getting help as the Fed and other central banks work to unfreeze credit: Their efforts have helped to pull down so-called Libor rates (London interbank offered rates) in recent weeks. Libor is a benchmark for many U.S. adjustable-rate mortgages.

The six-month dollar Libor rate was 3.43% on Wednesday, the lowest since Sept. 22 and down from a peak of 4.39% on Oct. 10.

--- Money market mutual funds:Yields on money market funds used to move in line with Fed changes, because a shift in the Fed’s rate would directly affect yields on the short-term corporate and government IOUs that funds buy.

But the credit crisis has upended the money markets. Even before the Fed’s previous half-point rate cut, on Oct. 8, average money fund yields had tumbled in September because of the plunge in Treasury bill yields, as safety-seeking investors rushed into those securities.

By contrast, the average annualized yield on money funds has edged higher since Oct. 8, from 1.47% then to 1.54% this week, according to iMoneyNet Inc. In part, that’s because T-bill yields have rebounded somewhat.

Still, the Fed is trying to bring down rates on other short-term IOUs, such as corporate commercial paper. The central bank began buying commercial paper this week for its own portfolio.

Connie Bugbee, managing editor of iMoneyNet in Westborough, Mass., said money fund investors should expect their yields to drop further in coming months, given the Fed’s latest rate cut.

How bad could it get? She noted that the last time the Fed’s rate was 1%, in 2003-04, money fund yields bottomed at 0.51%, on average.

--- Bank savings certificates: As I noted here on Monday, the good news for savers is that many banks aren’t in a hurry to cut deposit rates -- because it’s cheaper for them to lure consumers’ dollars than to fund themselves from other sources.

Since the previous half-point Fed rate cut on Oct. 8, the average yield on six-month CDs nationwide has edged down just 0.02 of a point, to 2.31% from 2.33%, according to Informa Research Services in Calabasas.

‘You’re not going to see CD yields tumbling off a cliff’ because of the latest Fed cut, said Greg McBride, senior analyst at Bankrate Inc. in North Palm Beach, Fla.

Even so, if you can afford to lock up some of your savings for six months to a year, you may earn significantly more than what you’d end up getting from a money market fund or bank money market account over the same period -- especially if the Fed keeps cutting interest rates.

Shop around online for CD yields on Bankrate.com, money-rates.com and bankingmyway.com.

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