DO YOU KNOW YOUR INTEREST RATES?

DO YOU KNOW YOUR INTEREST RATES? 

Interest rates are always a big topic of conversation in business meetings, in real estate transactions, when considering new credit cards and so on. It is not surprising, as various interest rates impact our lives in many different ways.

At the national level, the United States central bank, the Federal Reserve Bank, manipulates interest rates to adjust economic results. The Fed uses its bench rate in an attempt to regulate money supply and thus either stimulate or cool down the economy.

At the consumer level, interest rates impact how much we pay on our mortgage every month, how high our credit card outstandings get, whether we can afford payments on a new car and so on.

At the corporate level, business decisions are made based on prevailing interest rates as to when to float a new bond or  how to structure a balance sheet to include term debt debt, for example if the rate levels are appropriately cost-effective.

What are some of  the interest rates that are often in the news and are perhaps not completely understood? Once, at a real estate office meeting a mortgage banker mentioned  that “the Fed sets the Prime Rate” and no-one (but ME) batted an eye (I politely corrected him). Below are simple descriptions of the most common interest rates:

Fed Funds Rate

Prime Rate

LIBOR Rate

FED FUNDS RATE:  is set by the U.S. central bank, the Federal Reserve Bank during its periodic meetings. It is the rate that banks pay to the Fed when they purchase funds from the Fed “window”.

PRIME RATE: is generally the best rate banks charge their “prime” borrowers. This rate is set by each individual bank. The Prime Rate can vary from bank to bank, but most institutions fall in line with the major U.S. money center banks when setting their own. When a loan agreement calls for the Prime Rate, the document will spell out the mechanism for determining that rate.

LIBOR RATE - stands for London Interbank Borrowing Rate and is mostly used for wholesale or corporate loans. Recently LIBOR has been creeping into some retail or consumer loans as a benchmark as well. It is generally quoted as a one-month or 30-day rate, but there are quotes for 60 or 180-day Libor as well. Similarly to the Prime Rate, each bank (with a trading presence in London) can set its own LIBOR rate. Loan documents that call for LIBOR generally specify that the rate will be determined by averaging the rate of three specified reference banks on the morning of the day when the rate is to be set for the upcoming borrowing period.

Once you know the distinction between the various interest rates, perhaps the most important thing for a consumer to understand is that pretty much all rates are NEGOTIABLE.

Note: Image courtesy of renjith krishnan of freedigitalphotos.net