MONEY COMMENT
Debt Is Costly, Despite Low Interest Rates

By Cliff D'Arcy
June 26, 2003

Yesterday, the Federal Reserve, the US central bank, did what was widely predicted by market pundits: it trimmed US interest rates by 0.25% to a 45-year low of 1%. Back on 6 February, the Monetary Policy Committee of the Bank of England cut the UK base rate to 3.75%, a 48-year low.

So, the UK base rate is 3.75%, the US rate is a mere 1%, and the European Central Bank reduced the rate used by the 12-nation eurozone to 2% earlier this month. Wow – we can all celebrate the lowest borrowing rates for generations by splurging on credit, right? Wrong!

Most mortgage lenders react to a base-rate fall by reducing their standard variable rates and discounted deals, in order to remain competitive. However, they usually view a rate decrease as an opportunity to boost their margins. They often drop mortgage rates by say, 0.1% or 0.15%, in response to a 0.25% cut. I think this smacks of exploitation, so that's why I have a tracker mortgage, which rises and falls exactly in line with the underlying base rate.

With over £700 billion (!) of outstanding mortgage debt, every 0.25% fall in mortgage rates saves us around £1.75 billion a year in interest, which provides a useful boost to our domestic finances. However, one major problem is that, by and large, our £160 billion (eek!) of consumer credit - personal loans and plastic card debt - is unaffected by the falling base rate.

When the base rate drops, it's true that the market-leading personal loan providers do prune their APRs in order to remain in the Best Buy tables. When it becomes cheaper for them to borrow money, the best lenders do pass on some of their saving to new borrowers. Unfortunately, as most personal loans are fixed-rate deals, existing borrowers gain no benefit from falling loan rates. However, borrowers can re-finance their loans if they are fixed at unattractively high rates.

The real baddies when it comes to maintaining excessive interest rates in the face of base rate cuts are the credit and store card companies. A typical credit card currently charges interest at four times the base rate, around 15%. Most charge between 12% and 25%, with store card issuers often levying APRs in excess of 30%!

If your card issuer hasn't lowered its standard interest rate in response to the declining base rate (some have even raised their rates in recent years!), you can arrange your own personalised rate cut. Simply read this article on how to take advantage of zero-interest offers and other cunning conduct.

Finally, one thing you should never do is pay no more than the minimum on your credit card each month. As we explain in this article, it is enormously expensive. If your card charges interest at 1.5% a month and you repay the minimum 2% a month, it will take you almost 40 years to repay a modest debt! So, unless you want debts that last as long as your career, get Foolish now!

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