Falling interest rate environments create challenging times for lenders. Current and prospective borrowers wonder when interest rates on loans will decrease, and those who represent or refer customers to lenders, including dealers, manufacturers and loan brokers, get asked the same question. What the public hears is, “The Federal Reserve is cutting interest rates,” and assumes borrowing will be cheaper; in a few areas it may be, such as payments on credit card debt and loans tied to the “prime rate.” The broader reality is boat loan rates depend on a number of variables, including the lenders’ “cost of money,” and the borrowers’ needs and creditworthiness.
Interest rates under Fed control are the so-called “discount rate” and “federal funds rate.” On April 30, the rates were cut for the seventh time in as many months to 2.25 and 2.0 percent, respectively. They may be lowered further in response to concerns about a generally perceived weakening of the overall U.S. economy and particularly the vulnerability of the housing market. Both types of loans are only available to banks, the first reflects an up to 30-day loan from the Fed to a bank, the second is charged on overnight loans between banks. Neither have much immediate impact on consumer loan rates, yet these are the numbers tossed about in the news and at cocktail parties.
Boat rates usually reflect longer-term borrowing. Boat lenders start pricing at benchmarks that reflect the average life – from booking to payoff – of a boat loan, which is about four years, according to the National Marine Bankers Association. These longer rates are determined in credit market trading, and though influenced by the Fed, do not necessarily mimic the same direction or degree of change. Thus, when short rates are cut, longer rates can decrease, but they can also stay the same, or increase. During the first quarter of 2008, the Fed funds rate was running below the 5-Year Treasury Note; logic would suggest the reverse, a higher rate for the longer term exposure. As the chart in the next column shows, longer rates are now producing higher yields.
Regardless which base rate a lender may choose (internal cost of funds, various duration U.S. Treasury Note rates, offshore Libor comparables, etc.), pricing goes up from there to cover marketing, loan servicing, profit wanted, and allowance for risk (some lenders use more than 20 components to price their loans). For a boat loan, assume these respective costs are 2 percent, 1 percent, 2 percent and 0.5 percent for a total overhead of 5.5 percent. Add that onto the 5-Year Treasury “benchmark” and the price of the loan to the consumer borrower is 8.53 percent. If the math is accurate, a loan paying off in 5-years will produce this yield. If it turns over more quickly, or stays on the books longer (either are risks), the yield will reflect the underlying benchmark at the time the loan pays off.
Some lenders may have lower overhead due to volume or efficiency, others may need to set rates higher because of a greater loss rate or lower average credit scores of applicants (small boat vs. yacht buyers?). In the scheme of things, rates in any given market won’t be wildly different. Boating’s ace in the hole is that loans with 15-or-plus-year terms won’t see a dramatic change in monthly payments even with a point or two difference in rate.
Boat loan borrowers also enjoy interest rates that have usually been lower due to historical positives. These include healthy competition for their business, collateral (e.g., the boat) attached to the loan that holds up better than some other products, and higher (that is, less risky) applicant credit scores.
Interest rates being pushed down by the Fed represent the ever-present double-edged sword. On the surface, they can be good news for borrowers and will, at some level, stimulate consumers and businesses to buy things and expand. Inherently, they reflect an economy believed headed the wrong way. At some point, when the Fed eases enough, the great cycle will stabilize and gain steam. Then, alas, the governors will move the other way to push rates up with a goal to slow things down.
Greg Proteau writes about boating and marine finance industry trends, companies, people and ideas. He served as director of communications and PR for the NMMA and was the founding executive director of the National Marine Bankers Association. Currently he is a consultant to manufacturers, marketing agencies, service providers and organizations within and outside the marine sector and serves as executive director of Boating Writers International.