While most borrowers will have to wait a few months to see a benefit from the drop in the prime rate, savers have already seen interest paid on their money markets and certificate of deposits drop.
"They [banks] will cut your savings rates, but they are loath to cut their loan rates," said Hugo H. Ottolenghi, editor of 100 Highest Yields, a consumer newsletter on banking based in North Palm Beach, Fla.
Banks in recent weeks have been dropping their rates on money markets and CDs in anticipation of lowering their prime. That is why it took banks nearly three weeks to react to the Dec. 18 decision of the Federal Reserve to drop its discount rate from 7 percent to 6.5 percent, according to Ottolenghi. The discount rate is what the Federal Reserve charges private financial institutes to borrow money.
Ottolenghi said savers should expect further interest drops as the Federal Reserve tries to stimulate the economy. "This thing could continue to go down and down," he said, estimating that interest rates will not return to their present level for about two years.
To protect themselves from this anticipated drop, savers should put their money into fixed-rate certificates of deposits of about 2 1/2 years, Ottolenghi said.
The national average yield for certificates of deposits at the beginning of January is 7.3 percent, he said, adding that the rates are higher in the Baltimore-Washington area.
While savers have already felt the effect of the prime rate change, borrowers will have to wait awhile longer.
Rates on personal loans will probably not drop for a couple of months, Ottolenghi said. Interest on long-term loans like mortgages and car loans are more influenced by the long-term prospects for the economy, he said.
In fact, right now the events in the Persian Gulf are having more effect on mortgage rates than the prime rate, Ottolenghi said.
Many home equity loans and some credit card rates are directly tied to the prime rate, with the interest rates one or more interest points above the prime. But even in these cases, most of the rates are adjusted monthly or every three months and the borrower will have to wait for these changes, Ottolenghi said.
The prime rate is defined as the rate that banks charge their best commercial customers. But in reality, no one gets this rate, Ottolenghi said. "Its more or a benchmark figure than anything else," he said. "The average person and the average business are not getting prime," he said.
Paul F. Nastasi, a personal financial consultant for A.J. Perry & Co. Inc., a fee-only financial planning firm, also expects interest rates for savers to continue to fall.
Besides locking into certificate of deposits for two to five years, he also suggests that savers invest in mutual funds of government bonds that mature in two to five years. Besides securing a fixed rate, the bonds will go up in value as interest rates rise and they can be sold, unlike certificate of deposits.