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April 20, 2001: 4:26 p.m. ET

Falling interest rates help more than just the stock market
By Staff Writer Mark Gongloff
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NEW YORK (CNNfn) - While Wall Street loved this week's interest-rate cut by the Federal Reserve, you don't have to be a day trader to benefit from it.

The Fed cut its target for the federal funds rate, an overnight bank lending rate, by a half percentage point Wednesday to 4.5 percent, the fourth cut by the Fed this year and the second between its regular meetings. Some economists think the Fed will likely cut again, at or before its meeting scheduled for May 15, in a continuing effort to breathe life into the sluggish U.S. economy.

This is bad news for people whose financial health depends on certificates of deposit or savings accounts, but it's good news for people who want to take out a loan or refinance their debt at a cheaper rate.

"Do what every human being in America is considering: refinance," said David Caruso, Certified Financial Planner (CFP) and co-author of Let's Talk Money: Your Complete Personal Finance Guide.

Consumers saddled with what Caruso and other financial planners call "garbage" debt -- credit-card debt, automobile loans and other debts that aren't tax-deductible and usually have a high interest rate -- can take advantage of low interest rates to pay off that debt quickly.

"The liability side of the balance sheet can kill you in tough times," Caruso said. "This is one good way of shoring up the 'horror' side of the balance sheet."

Mark Groesbeck, a CFP with the Stanford Group in Houston, said he saved a client about $1,000 a month in loan payments by rolling two mortgages and a car loan into one low-interest loan.

"Now he can accelerate his debt payment if he wants or increase his cash flow," Groesbeck said.

Paying down debt more quickly can have a dramatic effect on your finances in the long run. "Generally, on a 30-year mortgage, (you can) cut the term from 30 years to 22 years just by paying an extra $100 a month," Groesbeck said.

Home equity loans

Home-equity loans -- loans that use the equity in your home as collateral -- are increasingly popular tools for refinancing.

"A lot of consumer advocates say you shouldn't put your home at stake, and that's advice worth considering," Fritz Elmendorf, spokesman for the Consumer Bankers Association, said. "But using your home gives you access to credit that's cheaper than other sources."

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    Most home-equity loans have adjustable interest rates tied to the prime rate, meaning this could be the time to find one with a cheaper rate or other attractive features and lock yourself into it.

    If you don't have a lot of equity built up in your home, you could still be eligible for a home-equity loan, under an arrangement called a high loan-to-value loan, which could be worth up to 125 percent of your equity. "You'll pay more for it, but it still should be less than your credit-card rate," Elmendorf said.

    Other rate-cut benefits

    Even if you don't want to refinance or open a new loan, you can still benefit from interest-rate cuts without lifting a finger.

    Ninety percent of all home-equity loans and 61 percent of all credit cards have interest rates that depend on the prime lending rate, according to Elmendorf.

    The impact of the Fed's rate cut on such debt will be felt almost immediately -- "in next month's billing cycle" Elmendorf said.

    Many fixed credit-cards will probably lower rates to compete with variable-rate cards, and now might be a good time to apply for a low-introductory rate card to consolidate your existing credit-card debt. It's crucial, though, that you can make your payments on time and, if possible, pay the debt off before the introductory period ends.

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    Fed rate cuts also eventually affect automobile loan rates, but only in the long run, as other falling interest rates make the auto-financing market more competitive.

    Mortgage rates, which are tied to the 10-year Treasury note, are not directly affected by the federal funds rate. In fact, mortgage rates are actually higher than they were a month ago. Still, they will follow the Fed rate in the long run.

    Steven Kaye, CFP and president of the American Economic Planning Group Inc. in Watchung, N.J., also pointed out that falling interest rates make lump-sum pension plans more valuable over time.

    Some negative effects of an interest-rate cut include the possibility of the dollar weakening against other currencies and bond rates falling, which could impact people who rely on bonds for income.

    Kaye suggested people sell bonds before the rates fall too much, while CFP Mark Groesbeck suggested the possibility of a bond swap, in which one bond is traded tax-free for a higher-coupon bond. But such a swap takes careful planning, Groesbeck warned.

    Seek professional help

    But common sense is a more important tool for consumers than careful planning.

    "People have to think realistically, and I think the economy is pretty sobering right now, and people should consider their financial moves very soberly. Part of that is getting in less debt," Elmendorf of the Consumer Bankers Association said.

    A common mistake, according to Elmendorf and financial planners, is for people to refinance their credit card debt and then turn around and max out their credit cards again, leaving themselves with twice as much debt as before.

    Click here for a calculator that determines if you should refinance.

    "When you borrow to the max, you can't afford to take a hit on income, and unfortunately what we're seeing are layoffs and reductions in income and potentially an increase in the already high level of bankruptcies," Elmendorf said.

    Bankruptcies are on the rise, Elmendorf said, in part because people are trying to file before proposed changes to the bankruptcy law are passed by Congress, but also because layoffs are also on the rise.

    Elmendorf and financial planners agree that the best way to avoid bankruptcy court is to seek professional help.

    "Bankruptcies are very serious issues that can often be avoided by seeking help from a professional debt counseling service that will intervene with creditors," Elmendorf said. graphic