What are these Rates?
They are important. Each of these rates of interest will have an impact upon the level of economic growth (read: home price increases, employment, wages earned etc). Also, they are totally interconnected.
Let’s take our skinny daddy long legs and step into this interconnected web.
Fed Funds Rate:
The Federal Funds Rate is the rate at which banks lend to each other. It is the most widely watched rate that the Federal Reserve (Fed) sets. This will directly influence mortgage rates and the interest rates on most all short term bonds. For more see: What is the Federal Funds Rate?
Discount Rate:
This is the interest rate the Fed offers member banks that need to borrow money. This is typically an overnight rate. The place banks borrow from at the Fed is called the “Discount Window”. If you hear this term, just think of the Discount Window as a “drive up window”. Instead of handing out Happy Meals, the Fed is handing out loans to commercial banks at a set rate of interest.
Who are these mysterious “member banks”? They are any state chartered commercial bank that would like to become a member of the Federal Reserve System. These state chartered banks are supervised by one of the 12 regional Federal Reserve Banks.
Why does a discount rate matter? The higher the discount rate , the higher the Fed Funds Rate will likely be. The Fed Funds rate influences where the Prime Rate will be. The higher the Prime Rate is, the more costly a mortgage will be. Costly mortgages will put a damper on new home purchases (as some people may not be able to afford the mortgage).
Recent News: After the market closed on February 19th 2010, the Fed raised the discount rate from 0.50% to 0.75%. For more on this read: What The Hike in the Discount Rate Means?
Prime Rate:
The Prime Rate refers to the average rate of interest that a bank extends mortgages to clients. Typically, the prime rate is about 300 basis points (100 basis points = 1 percentage point) or 3% over the Fed Funds rate. The Fed Funds Rate today is between 0%-0.25%, hence the Prime rate is at 3.25%.
The more credit-worthy you are, the lower your additional cost over the Fed Funds Rate will be. For more read: Understanding Your Credit Worth.
Related Articles: What is the Federal Funds Rate?, What is a Dual Mandate?, What Does it Mean to Print Money?
