Interest Rates????

I know there is a lot of confusion out there about all the different interest rates and what they all mean. I cant tell you how many times someone that i was doing a mortgage for call me and said "Hey, i heard they just dropped the rates again by a half a percent so my rate is a half a percent lower now right??" WRONG!!! First of all what rate dropped??? Fed Funds, Fed Discount, Prime?? There are as many rates for in the financial world as there are fish in the sea. The key is to understand what they all mean and what people really want to know is the impact that those rates have on their daily lives.

FED FUNDS RATE- ( currently at 2.25%) Click on the link to read the actual definition of what this is. But, to put it into plain English is the the rate that banks lend money to each other at. All banks are required to maintain a reserve on hand. That reserve amount changes but lets just say it is 10%. So if a bank has $100 million in demand account like a checking or saving account then they have to keep 10% of that and not lend it out. This does not always happen so if a bank lends out more money they have to borrow enough to have 10% on hand by the end of the day. They do that by borrowing it from a bank that has a surplus reserve. That way both banks are in compliance and the bank that didn't lend out all their money is still making some interest on their surplus. But usually it is for less then 24 hours. Another major point to all this is that the FED does NOT set the Fed Funds Rate, banks do. The FED sets a target rate and then adjusts the money supply to try to come close to that target.

So what does that mean to you and me? Well, Absolutely nothing!!! Unless that is you are a bank, but suffice it to say if you are a bank you better know all this already. :) I do have to point out here that when i say absolutely nothing, that is not exactly true. All interest rates are tied in with each other in one way or another the say way that when a butterfly flaps it's wings in Africa it rains in London. Ok, not quite that bad but close.

This is how the relationship works. The theory is that is the fed fund rate is lower then banks more be more actively seeking loans knowing that if they lend out too much they can always borrow the money cheaply from another bank. That means that bank with have looser guidelines for loans, but it doesn't say what rate they will loan the money out to the public at does it.

So when you see those little adds stating that the fed dropped rates again so you can get a $500,000 mortgage for less then $1,600 a month. Know that they are full of crap, and it is nothing more then dishonest advertising. (I will talk later about how those places get away with those ads)

Next time i will talk about the Discount Rate, the one the Fed actually does control.