Fed cuts key interest rate

As expected, the Federal Reserve yesterday trimmed a key bank interest rate by one-quarter of a percentage point from 2.25 percent to just 2 percent. The Fed has now lowered the federal funds rate 3 percentage points in the last seven months.

In its statement, the Fed noted that turmoil in the financial markets, tougher requirements for new loans and weak housing markets have put pressure on the U.S. economy.

"Tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters," the Fed said.

One of the Fed’s primary objectives is to protect the U.S. economy from inflation. That means the Fed has to find a balance between lower interest rates and higher prices. This week’s statement said the Fed would "continue to monitor inflation developments carefully."

The Fed doesn’t directly control interest rates on home loans, credit cards or other consumer debts. But this week’s rate cut could still be a positive development for many borrowers since the Fed’s actions can indirectly influence the interest rates on some loans.

Rate cut may aid ARM borrowers
The Fed’s previous rate cuts were especially welcome for borrowers who were facing resets on adjustable-rate mortgages (ARMs) tied to certain indices. Interest rates on ARMs often are tied to the U.S. Treasury or the London Interbank Offer Rate (Libor) rate, both of which have dropped this year.

As an indirect result of the Fed’s rate cuts, some ARM adjustments and resets have been much smaller and less painful for borrowers than they otherwise would have been. The savings due to smaller ARM rate adjustments could amount to hundreds of dollars a month for some homeowners.

The Fed’s rate cuts also influence the prime rate, which is the rate banks offer their best customers. This means short-term interest rates on home equity lines of credit, ARMs tied to the prime rate, auto loans, and some credit cards may move lower as well.

 

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