What’s in a Rate?
Today’s Ask Jack question explores the rate environment, and how Members Credit Union sets its rates.
Why when the Federal Reserve has hit historical low lending rate of 1% that the credit union raises their lending rates CAR 6.25% Best vs last months of 6.0% and the unsecured credit line 12.5% vs last months 11.75% it seems they are moving in the wrong direction. I would think at the least to stay pat.”
- Loren W.
To answer this question let’s first start with an explanation of what the Federal Reserve Target Rate (FFTR) is and what it is not. The FFTR is actually not even a rate at all. It’s is a target. The Federal Reserve’s twelve regional banks, after setting aside a mandatory level of deposits, makes overnight or short-term funds available to financial institutions to cover the ebb and flow of daily expenses (and, more importantly to meet mandatory reserve limits). The rate on these loans is determined by market conditions, which the U.S. Federal Reserve manipulates (via the buying/selling of treasuries, adjustment of reserve requirements, etc.) to meet the target rate. These bank-to-bank loans are as close to risk-free as loans can get. This is because these loans are: a) Extremely short-term, often paid back in full within several hours; and b) Extremely small in relationship to the borrower’s (a bank with millions of dollars on deposit) ability to repay.
This distinguishes overnight bank-to-bank borrowing from traditional consumer borrowing quite dramatically. That said, many financial institutions use the FFTR as an index by which they determine certain consumer loan rates. Take the “prime rate”, for example. Many consumers with home equity loans have a rate tied to “prime”. “Prime” is generally three percentage points higher than the FFTR. So, if the FFTR is 1%, “Prime” is typically 4%. If you have a home equity line of credit for “prime plus one,” then your rate is 5%.
Different types of consumer loans, though, are tied to different indices. First mortgage and student loans, for example, are often tied to the behavior of treasury bond yields. Because changes in FFTR do no necessarily affect treasury bond yields, these rates move up and down independently from the FFTR.
A component of the rate we attach to Members Credit Union’s unsecured variable-rate loans is tied to the 2-year Treasury note (T-Note). Each month from March 2008 to June 2008, 2-year T-Note yields actually increased. The good news is that since then, we have seen a marked decrease in that index. We expect this trend to continue, which will mean a likely rate reduction on unsecured variable rate loans when they are next adjusted January 1, 2009.
Secured, fixed-rate loans such as automobile loans are set by our rate committee based on market factors such as competitor rates, member demand, and our balance sheet. Historically, we have maintained extremely competitive rates. For example, the national average 60-month new automobile loan rate is currently 7.19%, while the national average used automobile rate is 7.67%. Our current rate of 6.00% on both new and used automobile loans (with 20% down and automatic payments through an MCU account) compares quite favorably to these figures, especially when you consider that the above national average rates assume a minimum credit score of 700.
Members Credit Union returns earnings to members in the form of lower loan rates, higher deposit returns, fewer and lower fees, and improved service offerings. This philosophy has mandated that our rate sheet gives members the best possible prices on loans and deposit products we can possibly offer. We spend a great amount of time and energy creating this scenario for members, and I couldn’t be happier with the results. Across the board, we are confident that our rates and fee schedule, combined with our branch footprint and service offerings, are the best deal possible for members.
Then why is are our goverment telling us these lower fed rates are to lower the interest rates for personal loans as well as car/credit card rates which are typically longer period of times then what Jack has stated who are we to believe??????
yours, Mr. Whan
Mr. Whan,
Thank you for your comment! Perhaps I didn’t explain the relationship between the Fed Rate and consumer loan rates clearly enough. The Fed Rate allows banks to more affordably borrow from other banks. In most cases, this decrease in overnight expenses allows cost savings to be passed on to consumers.
This is, however, an “apples to oranges” comparison. Overnight bank-to-bank lending is a completely different animal than financial institution to consumer lending. Loan terms, risk levels, loan debt-to-value ratios, etc. are vastly different.
Lower FFTR does not necessarily mean lower consumer loan rates for this very reason. Because a component of our rate is tied to a Treasury Bill index, such market factors such as FFTR play a small role in the rate environment. However, that is a highly indirect and inconsistent factor. Just as you would not want the federal government setting prices for eggs, milk, gasoline, and automobiles, I would imagine you appreciate a financial institution’s ability to adjust rates independently. This way, market factors (pairing willing “buyers” with willing “sellers”) can dictate pricing.
Again, there are two pieces of good news to share in terms of variable rate loans at Members Credit Union. 1) Our rates are currently very competitive in today’s credit market; and 2) The 2-Year T-Note has fallen to a level that almost guarantees we drop our rates on the next quarterly rate committee meeting (for 1/1/2009).