Why Borrowers May Not Benefit From Rate Cut; Many Loans Are Now Tied To Benchmark That Remains High Despite Fed's Moves
Not all borrowers are benefiting from the Fed's moves to cut interest rates. The problem: Loans that are tied to a variety of interest-rate benchmarks -- some of which aren't necessarily moving in lockstep with Fed action.</br></br>Yesterday, the Federal Reserve cut short-term interest rates by a quarter of a percentage point to 4.25% -- the central bank's third rate cut since mid-September -- to help ease the credit crunch and reduce the economy's chances of falling into a recession. The moves have helped some borrowers who have seen interest rates on their credit cards and home-equity lines of credit fall. Interest rates on many fixed-rate mortgages also have dropped amid a decline in Treasury yields as investors sought out safe investments.</br></br>But rates remain stubbornly high on other loans, including student debt and many adjustable-rate loans made to the same type of subprime borrowers whose troubles are now reverberating throughout the global financial system. These rates remain high because many of these loans are tied to the London interbank offered rate, or Libor, and not to more conventional interest-rate benchmarks such as Treasurys or banks' prime rate.</br></br>Libor, which is an interest rate banks charge on loans to each other, normally tracks the federal-funds rate closely. But continuing worries over the credit crisis have kept Libor unusually high -- partly because banks are reluctant to lend to one another -- even as other short-term interest rates have fallen in recent months. The U.S. dollar three-month Libor yesterday was 5.11%, down from 5.36% in late June. Over the same period, three-month Treasury bill yields have fallen much more steeply, to 2.95% from 4.8%. "The Libor spread is screaming that there is a big, big stress point in the banking system," says James Bianco, president of Bianco Research LLC, a market-research firm in Chicago.</br></br>Borrowers may need to read the fine print of their loan agreement or contact their lender to know what benchmark their loan is tied to. The biggest impact is likely to be felt among borrowers with ARMs that are about to reset. "If you have a Libor-indexed ARM and you're facing a reset, that's going to be very disadvantageous because of the divergence between the Libor and Treasury yields," says Greg McBride, a senior financial analyst at Bankrate.com.