MOUNT VERNON — Time will tell what the long-term effect of the Federal Reserve’s decision to cut a key interest rate on Tuesday will be, but the move should be beneficial for some.
Homeowners with adjustable rate mortgages could see a decrease in their rates when the ARM resets, said William Melick, Gensemer professor of economics at Kenyon College.
The Fed cut the federal funds rate, which is the rate banks charge each other on overnight loans, from 4.25 percent to 3.5 percent. The dramatic cut was the largest one-day cut in recent history. The Fed said it decided to cut the rate “in view of a weakening of the economic outlook and increasing downside risks to growth.”
Melick said there is no guarantee the cut in the federal funds rate will lead to a reduction in other rates, although it usually does. If the cut in the federal funds rate does lead to a reduction in the prime rate — the interest rate at which banks lend to customers — or to some other rate to which adjustable rate mortgages are tied, then homeowners might find it advantageous to refinance their mortgage and reduce their monthly payments.
The long-term effect of the rate cut on the nation’s ailing housing market is unknown, but the cut will not fix the problem overnight. The cut may not loosen lending standards for new home buyers, however, which began to tighten last year as the housing crisis made national headlines. Lax lending standards were blamed for a spike in foreclosures. Subprime mortgages, generally given to borrowers with poor credit and often requiring little to no downpayment, have now all but disappeared.
Individuals who are already embroiled in foreclosure proceedings, as well as homeowners with fixed rate mortgages, should be relatively unaffected by the latest cut.
“I think there will be more cuts,” said Kevin Spearman of Spearman Financial Services. “It may be a good thing, especially for the housing market, and may allow people to [get out of ARM mortgages] and lock in a mortgage with a fixed and reasonable rate, and could shore up some of the defaults.”
The bad news is that interest rates on savings accounts, certificates of deposit and money market accounts will also decrease with a cut in the Fed rate. But the cut may benefit investors, despite the skittishness of investors over the last several days.
Spearman said current market conditions make it a good time for people to invest. He said he thinks more rate cuts are necessary to get people to invest their money as opposed to putting it in a savings account.
“When times get tough, people have a tendency not to invest, when there probably couldn’t be a better time,” he said.
Spearman said when the markets are doing well, everyone wants to invest.
Before the Fed’s rate cut, the Dow Jones industrial future was down more than 500 points. After the announcement, the Dow made a slight comeback, and closed down about 128 points.