How the Fed Rate Drop Impacts Your Finances

How the Fed Rate Drop Impacts Your Finances

By Frank Madeira, SVP of Finance

You’ve likely seen or read the news stories about the Federal Reserve’s decision to cut interest rates1. Do you wonder what this means for you, and how it might impact your finances and loans? Does it mean all loans are now offered with a 0% interest rate? Why haven’t my financial institution’s rates dropped to zero? Where do the numbers come from? Let me explain. The key factor in understanding the fed rate, also referred to as the fed rate drop, and its impact on you is knowing the difference between the fed rate and the prime rate.

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The fed rate, which is now at 0% for the first time since the 2008 recession, is the rate that banks charge each other for short-term loans, established by the Federal Open Market Committee2. The prime rate3, now at 3.25%, is an interest rate determined by individual banks, not the Federal Reserve. That said, the prime rate is often generated with the fed rate in consideration. It is often used as a reference rate (also called the base rate) for many types of loans, including loans to small businesses and credit card loans. While the Fed Funds rate has significant influence over all short-term rates, it is only one variable in the pricing equation. There are several other factors that go into loan pricing algorithms, such as the loan term, credit risk of the borrower, availability of collateral, market demand, market rates, and whether the rate is fixed or variable.”

For example, the loan term has a notable influence over the pricing factor. The Fed Funds rate is an overnight borrowing rate. The key differentiator is that loans the typical consumer takes out are much longer in term (such as a 30-year mortgage), which means they are pegged to longer-term rates such as Treasury bond yields. Even though the Fed Funds rate fell by 1.00%, all loan rates will not necessarily come down a commensurate amount. Longer-term Treasury yields did not also fall by 1.00%, which is why some consumer loan rates have not dropped.

Consumer rates established by Affinity and other financial institutions are based in part on the prime rate most notably posted by the Wall Street Journal,4 and the prime rate generally moves with Fed Funds. Variable rate revolving loan products such as credit cards and home equity lines of credit will generally move with the prime rate. Fixed rate consumer loans may also use prime to set rates but are subject to the other pricing factors mentioned above. That's why you may see unchanged rates in certain products despite the interest rate headlines.

In conclusion, the fed rate drop does not always impact you directly because it is the prime rate, not the fed rate, that directs the interest rate on your loans. However, the fed rate does have an impact on the rates that affect you. With longer-term loans and credit cards, there are several other factors that are taken into consideration to create your interest rate. So you may in fact see interest rates fall during this time because of the influence the fed rate has on the prime rate.

If you have any questions, or would like additional information about Affinity’s loans and interest rates, you can always connect with us by calling our member service center or scheduling an appointment to talk with a financial expert.

                                                   

This information is for informational purposes only and is intended to provide general guidance and does not constitute legal, tax, or financial advice. Each person’s circumstances are different and may not apply to the specific information provided. You should seek the advice of a financial professional, tax consultant, and/or legal counsel to discuss your specific needs before making any financial or other commitments regarding the matters related to your condition are made.  

1 Retrieved from https://www.washingtonpost.com

2 Retrieved from https://www.federalreserve.gov/monetarypolicy/fomc.htm

3 Retrieved from https://www.federalreserve.gov/faqs/credit_12846.htm

4 Retrieved from https://www.wsj.com/market-data/bonds/moneyrates