Consumers Will Feel Impact of Rapidly Falling Interest Rates

We are in a new world of low interest rates that will likely be with us for a while. The 10-year Treasury rate fell to 0.75% on Friday. The yield curve is very flat; the 10-year is no more than 0.4 percentage points higher than any shorter-term Treasury.

The biggest impact on consumers is going to be on mortgage interest rates, which are falling to their lowest levels ever. The 30-year fixed rate is headed below 3%. The 15-year fixed is expected to fall below 2.5%. The mortgage refinance industry is returning to its glory days. In fact, refinancers are expected to be swamped with applications, which might delay closings. Those interested in refinancing should wait a week or so for posted rates to adjust downward. A rough rule of thumb is that the 30-year mortgage rate should be about 1.75 to 1.9 percentage points above the 10-year Treasury rate, and the 15-year mortgage rate a half-point less, or 1.25 to 1.4 points above.

Interest rates on new car loans are likely to drop below 5.0%. These rates are determined by the bank prime rate, which in turn is affected by Federal Reserve changes in the short-term interest rate. This will undoubtedly juice the car market a bit. Consumer loan rates in general should be a bit lower as well, though the uncertain economy and declining consumer sentiment might make consumers reluctant to add more debt.

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The drop in interest rates has been a temporary boon for holders of long-term Treasuries, as they have earned capital gains from the rise in bond prices. However, it is less beneficial for those just entering the long-term market because they are buying in at high prices. It is also not so good for holders of short-term Treasuries, since these bills hit maturity fairly quickly; investors/mutual funds must buy back in at high prices, earning very little in yield. Although the stock market is down for the moment, the low rates are likely to continue to drive investors to eventually search for yield back in equities, or perhaps try their luck in real estate. The housing market should be pretty hot this year, though prices are expected to jump because of low inventories.