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Home equity lines of credit have been among the first interest rates to fall after a Federal Reserve rate cut. But the Fed's Sept. 29 reduction won't turn John Q. Public into John D. Rockefeller overnight.
The Fed lowered the federal funds rate -- the one banks charge each other for overnight loans -- just 0.25 percent to 5.25 percent. That allows lenders to make lower rate loans, but the savings from such a small move will likely be tallied in tens of dollars, rather than hundreds.
It takes time
The benefit also won't show up on the bank statements of many current borrowers until later this month or early in November because lenders take their time bringing rates on existing home equity lines in line with indexes. The most popular benchmark -- the prime rate found in The Wall Street Journal each weekday -- dropped Sept. 30, from 8.5 percent to 8.25 percent.
"Typically on a home equity line, you're tied to prime," says Betty Feigenbaum, vice president of marketing for Webster Financial Corp. in Waterbury, Conn. "So when prime goes down, our rates immediately go down.
"New customers reap the benefit of it right away ... (but the existing borrower) is not going to benefit from the reduction for at least another month."
The Wall Street Journal prime
The all-important Journal number is derived from the base rate on corporate loans posted by at least 75 percent of the 30 largest U.S. banks. Because so many lenders tie their home equity line of credit rates to movements in the index, a borrower's monthly payment and interest are inexorably linked to the powers that be at Chase Manhattan Corp., BankAmerica Corp. and other banking behemoths.
"Any interest rate that is tied to prime is going to be the first" to move, says Independent Bankers Association of America spokesman Rob Rowe. "That's where the Wall Street Journal rate comes into play. It tends to be an average of a variety of primes."
The drop in the cost of home equity borrowing isn't exactly mind boggling, however.
Let's assume someone had a $50,000 balance on a line of credit at the Sept. 30 national average interest rate of 8.65 percent. Interest in the first year would total $4,030, with monthly payments equal to 2 percent of the outstanding balance. If the loan rate fell to 8.40 percent, the cost would drop just $121, to $3,909.
First-mortgage rates climb
Homeowners looking to borrow their equity have fared better than people looking to get into a house in the first place. That's because lenders use different underlying rates to price their home equity lines and first mortgages. Thirty-year, first-mortgage rates are often pegged to the yield on 10-year Treasury notes, which rose precipitously over the past few days. A drop in the value of the dollar against the yen last week, and Japanese sales of U.S. debt securities, were to blame. It has caused some lenders to raise first-mortgage rates by as much as three-quarters of a percentage point.
Although home equity borrowers, unlike first-mortgage borrowers, are gaining an advantage from rate trends, they will need to be patient. The timing of the Fed rate cut will delay the savings they will glean, Feigenbaum says.
It's all in the timing
Banks typically recalculate rates on either the first or last day of the month, she says. Because of the delay among the benchmark banks to react to the Fed move, the new prime rate didn't appear in the Journal until Oct. 1.
Webster Bank calibrated its rates at the end of the month, using the prime rate published on Sept. 30. So their customers will wait until the first of November to see the effects of the cut.
For Wells Fargo & Co. customers, it's a complicated story of timing as well.
The San Francisco-based bank uses the one-month jumbo certificate of deposit index published by the Federal Reserve Bank of New York to set rates for home equity lines of credit, says Colin Walsh, senior vice president for home equity acquisition. The number, which represents the average CD rates being offered by banks in the New York region, tends to move in smaller increments than the prime rate.
But the timing of rate adjustments for Wells customers varies according to their payment cycle, which can begin on any number of business days rather than the first or last of the month. The CD index actually rose after the Fed move because it had dropped on Sept. 24 and 25 in anticipation of the cut. So it turns out borrowers with a cycle that began before the cut actually would do better than those whose cycle began after it.
Rates could continue to fall
Confusing? Sure. But the fluctuations demonstrate that the Fed would have to initiate more drastic rate cuts, or a consistent pattern of cuts, to significantly slash home equity line of credit costs. The Federal Open Market Committee, which sets rate policy, is scheduled to meet next on Nov. 17 and Dec. 22.
"If rates continue to fall, you'll see the variable indexes come down," Walsh says. "As long as we can maintain our margins, if the CD index went down to 2 percent, we could continue to lower rates."
It stood at 5.37 percent on Oct. 7.
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