Everyone Is Googling Federal Interest Rates. Here’s Why.
Point of Interest
Even before the COVID-19 pandemic, the Federal Reserve was cutting interest rates to make mortgage refinancing and other borrowing options more attractive, leading to spikes in search traffic.
Over the past few months, there has been a big spike in internet search traffic for “Federal Reserve” and “interest rates.” In March, the search terms hit the peak of popularity. Why? Well, the Federal Reserve has been taking actions making borrowing money for a mortgage or to refinance much more attractive. People are able to get lower payments, afford more house and get a more positive overall borrowing experience.
What is the Federal Reserve, and what does it do?
The Federal Reserve is the central banking system of the United States charged with providing the country with monetary policies, regulating banks and ensuring financial stability. By most people’s accounts, the Federal Reserve is the most powerful financial institution on the planet.
Created in 1913 by Congress, the Federal Reserve, or “the Fed,” works through 12 regional Federal Banks to strike a balance between unemployment numbers, economic growth and the overall health of the economy. The high-level changes put out by the Fed may seem far outside of your realm, but the effects of the changes trickle down and can have direct and indirect effects on your financial situation.
How does the Federal Reserve affect my interest rates?
One of the most powerful responsibilities the Federal Reserve has is setting the federal funds rate. This range, represented as a percentage, is guidance on how much banks should charge other banks for loans. Your local banks are required to have a certain amount of cash to cover the loans that they issue to individuals. When the financial institution is short, it borrows from other banks, using that federal funds rate to stay compliant.
What does this have to do with you? Well, the federal funds rate helps set the prime lending rate, which is what banks charge their most creditworthy customers for a loan. When the federal funds rate is higher, you’ll pay more to borrow money. When this number is lower, the money will be less expensive to borrow.
This works inversely on savings and investments that accrue based on interest rates. When interest rates are low, it may be cheaper to borrow money, but because of that, you won’t be paid as much on your invested money that’s being used by banks to lend. When interest rates are high, you’ll get more on your investments driven by interest rates, but borrowing will be more expensive.
How the Federal Reserve affects the economy
The Fed not only affects your individual loans and investments but also has a major effect on the overall economy. When money is less expensive, businesses can do more to grow. When money is more expensive, though, businesses may tighten down their budgets.
Jack Choros, CMO of Sophisticated Investor, says, “Think of it this way. One of the quickest ways to become rich (or poor) is to leverage your investments i.e. borrow money so that you can amplify your gains. This can also cause you to amplify your losses should your securities go down in value. If the cost of borrowing goes up, all of a sudden it becomes more difficult to profit. If the cost of borrowing goes down, it makes taking the risk cheaper and more attractive.”
One might think that because of this, interest rates should always be kept as low as possible. But there’s a problem: This can cause unnecessary inflation and a decrease in purchasing power. Basically, the economy becomes unbalanced. To put things back in check, the Fed usually moves the interest rate back up. It’s a delicate balance with a lot of moving parts, but it’s critical to the success of the U.S. economy.
Important terms to know about the Federal Reserve
1. The discount rate – This is the interest rate that the Fed charges other banks for short-term loans. At the end of each day, banks must have a certain amount of cash (known as the reserve requirement) to cover outstanding loans. When banks are short, the bank may choose to borrow directly from the Fed. The interest rate charged is the discount rate.
2. The federal funds rate – This rate is what banks are guided to charge when the bank lends money to other banks to meet the reserve requirement. The federal funds rate is also what banks use to determine the prime lending rate, which helps to determine the rates you’ll get on loans or through investments.
3. The prime rate – This is the rate that banks will charge their most creditworthy customers on a loan. It’s expressed as a percentage and helps to dictate what every borrower will pay at a particular bank, credit union, lender or financial institution on a loan.
How to get the best interest rates
If you’re looking to take advantage of higher interest rates, you may look to put your money into investments like Certificate of Deposit (CDs) that return a fixed rate based on the interest rate. Just because interest rates are up, though, does not mean every bank is going to give you the same great returns. Take the time to shop for different banks to find the best rate. Keep in mind that many online banks will offer more impressive rates than brick-and-mortar branches.
The same is true when you’re borrowing to take advantage of lower interest rates. Find the bank, credit union, lender or financial institution willing to give you the best rate possible. Just don’t get tunnel vision and get rate-blind. You’ll want to look at the repayment terms, loan terms, fees and all other factors before deciding on a lender. Just because the interest rate is a lower number does not automatically mean it’s the best loan option.