Falling Interest Rates Help Home Owners

20-year low in bonds pushes mortgage rates down, but credit-card rates won't drop.

Americans planning to buy a home, refinance a mortgage, or buy a car got a late holiday gift this week: Interest rates skidded to their lowest level in two decades. The drop could put hundreds, even thousands of dollars of extra cash into consumer pockets.

"This is the kind of situation we hope for but seldom realize," says Douglas Baum, president of New Amsterdam Mortgage Corp. here. "Our phones have been ringing constantly" since the first reports of the interest-rate drop.

Mr. Baum notes that one client with a $100,000, 30-year mortgage at 8.75 percent could save close to $70 a month with a new, 7.25-percent mortgage. Monthly payments would drop from $751 to $682. And on bigger loans of $300,000 or more, even with refinancing fees, consumers could save up to $1,000 a month.

People are likely to spend much of this extra cash, further boosting the economy. But not all consumers will benefit: Rates for credit-card, home-equity, and personal debt won't likely drop.

On Monday, the yield on 30-year Treasury bonds tumbled to 5.73 percent, the lowest level in 20 years. Most mortgages, however, are linked to 10-year Treasury securities. Yields on the 10-year Treasuries fell to 5.50 percent Monday, part of the downward parade in rates.

Mortgage rates, now running around 7 percent on 30-year mortgages, are expected to drop into the 6 percent range. Rates that low are a major plus for consumers planning to buy a home or "a big ticket item, such as a car," says Arnold Kaufman, an analyst with Standard & Poor's Corp. in New York.

Consumers are not the only beneficiaries of the interest-rate drop. The "flip side" of rate declines is price appreciation. Millions of Americans who own bonds within contributory retirement-savings plans or Individual Retirement Accounts (IRAs) - or those who own bonds directly - could become richer through higher values in the bond market. This is because bond prices move in the opposite direction of interest rates. So bond owners profit through a combination of interest payments and the price appreciation in the value of the bonds.

"I've been thinking of getting out of bonds and adding more money to stocks," says Earl Zastro, a claims-adjustment superintendent in Chicago who plans to retire in the next few years.

But Mr. Zastro is suddenly big on bonds. Little wonder. His 401(k) retirement money is in a mutual fund invested in both stocks and bonds, both of which have been posting solid earnings gains lately.

But other consumers - especially those with high credit-card debt - won't necessarily benefit from the rate drop. Credit-card, home-equity, and personal-debt interest rates are tied to short-term rates, which are set by the Federal Reserve. And it's uncertain what the nation's central bank will do in coming weeks.

Asia and Greenspan

In looking for causes of the long-term bond-yield decline, analysts point to the new amounts of overseas money that have been pouring into the US Treasury market, as Asian investors in particular have been seeking a haven for their wealth.

But some analysts also say the "Greenspan factor" was the main catalyst. In a speech Jan. 3, Federal Reserve Board Chairman Alan Greenspan raised the dreaded D-word - deflation - a sharp decline in the prices of such assets as stocks and real estate. The last time deflation was a major problem was in the 1930s, when retail prices plummeted.

In his speech, Mr. Greenspan said that a severe price decline in the US, such as might occur because of a glut of cheap imports from Asia, was not a "significant near-term risk." But many bond traders and economists interpreted his remarks as suggesting that the Fed may push interest rates lower to offset a faltering economy. That would represent a sharp change in Fed policy. In 1997 the concern was that the Fed would raise interest rates to head off higher inflation.

"We are in uncharted waters now," with bond yields heading south, says Darrick Hills, an analyst with investment house Dain Bosworth & Co. in Minneapolis. Whatever the Fed does, the declining yield on the 30-year bond - or so-called "long bond" - suggests further rate reductions, says Alfred Goldman, chief economist for financial house A.G. Edwards & Sons in St. Louis. He expects the long bond to go to 5 percent this year. Many economists expect it to fall to at least 5.5 percent.

Whether lower rates will prompt a wave of new home purchases or refinancing remains unclear, given uncertainties about the US economy, such as the extent of future domestic growth.

Looking ahead

Opinions are split about what bond owners should do now.

Savers should "remain flexible," says Cadmus Hicks, with the financial firm John Nuveen & Co. in Chicago. His strategy: Buy bonds (or mutual-fund products) with shorter maturities, such as two years. If yields on long bonds edge back up, he says, an investor could roll his assets over into issues with a longer time frame and higher yields.

But Mr. Goldman says investors should lock into bonds with current rates before they take a deeper plunge.

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