HOW MUCH? - Federal Funds Rate

Intro To The Federal Funds Interest Rate


With all of the discussion lately in the financial news you might be wondering exactly what the Federal Funds Rate is and how it impacts your ability to get a loan or to get a good interest rate on a loan.

Federal Funds Rate Defined

The Federal Funds Rate is the rate of interest which banks charge to each other when they loan each other money or the rate at which the Federal Reserve will loan banks money on an overnight basis to help them meet their reserve needs. Currently, the Federal Funds rate is quoted at 0% to 0.25% according to the most recent adjustment. This is the lowest rate that banks have ever been allowed to borrow money, and in reality, this should be a very positive thing to help get the economy moving in the right direction.

Federal Funds Rate Vs. Prime Rate

The Federal Funds Rate which is 0% to 0.25% and the Prime Rate which is currently 3.25% are not the same thing. Prime Rate applies to loans that are typically offered to those who have the best possible credit rating, high account balances at a bank where they're loaning money and in many cases have little (or no) need to actually borrow money! Federal Funds Rate is the rate at which Bank A loans money to Bank B or banks borrow money overnight from the Federal Reserve to meet their immediate cash reserve needs.

How the Federal Reserve Helps

Banks are required by law to maintain certain amounts of money in reserve based on their assets and liabilities. The Federal Reserve typically sets this amount at 10% of the banks demand and of course most banks are in the business of making loans which result in their reserve funds being depleted. In order to stay within the regulations laid out by the Federal Reserve, the banks borrow money either from another bank or from the Federal Reserve. This helps keep the bank liquid.

The Impact of Federal Funds Rate Cuts

When the Federal Reserve makes a change in the fed funds rate, it's typically done during recessions and other times where the economy is in an overall slow period of growth. If the Federal Reserve makes a determination that says the economy is growing too quickly then they are likely to raise rates to help slow growth by causing an environment where the interest rates and payments on money that is owed is higher.

Fed Funds Rate Being Cut
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Higher Interest Rates Make Sense In Some Situations

While it's believed that in some cases these increases can result in forced selling or defaulting of loans (as seen during this economic crisis we currently find ourselves in) short term interest rates that are slightly higher can have a positive effect on gross domestic production and a negative effect on stocks and housing.

See also: Interest Rate Changes, How The Fed Funds Rate Impacts Your Loan




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