| The federal government seems to have incredible | | | | rates paid overnight, the discount rate is set by the |
| control over the financial policy in the United States, but | | | | federal government. |
| in fact, the role of the federal government is less | | | | How are Mortgage Rates Involved? |
| controlling and more of a guiding or shaping process. | | | | Mortgage rates have a tremendous ability to affect |
| Some examples of this are seen in the federal funds | | | | the economy. When mortgage interest rates are high, |
| rate and mortgage rates, both key indicators of the | | | | home sales drop and new construction grinds to a halt. |
| economy. Neither of these rates is set by the federal | | | | The mortgage rates are set by banks, and, while |
| government. | | | | loosely based in the prime rate, take into consideration |
| What is the Federal Funds Rate? | | | | other factors, such as the housing market and the |
| The federal funds rate is the average rate that banks | | | | credit worthiness of borrowers. Mortgage rates are |
| use to loan each other money. The loans normally | | | | set based on how secure banks feel about the |
| occur overnight. The reason for interbank loans is | | | | economy at any given time. While much speculation |
| because of federal regulations. One of these | | | | occurs each time the prime rate is changed, it is |
| regulations requires that each bank keep a certain | | | | important to realize that the mortgage rate does not |
| amount of cash reserves on hand. The amount is | | | | necessarily rise and fall at the same time as the prime |
| typically 10% of the demand account totals for the | | | | rate, the federal funds rate or the discount rate. |
| bank. Demand accounts are those that the owner can | | | | However, when interest rates are low in all of these |
| call at any time, such as a checking or savings | | | | areas, they are typically low in mortgage rates as well; |
| account. | | | | as they increase they subsequently increase in the |
| Each day, money flows into and out of the bank. At | | | | housing industry as well. |
| the end of the day some banks will have a surplus, | | | | Why Should the Average Citizen Care About the |
| while others will have a deficit. The banks that have a | | | | Federal Funds Rate? |
| surplus of cash reserves can loan them to the backs | | | | The federal fund rate affects every part of the |
| without a reserve. The interest rate is called the | | | | economy. The federal funds rate is tied to the interest |
| federal funds rate, and is negotiated between the | | | | rate, or the cost of borrowing money. When interest |
| banks. When you hear talk about the federal funds | | | | rates are low, it is less expensive to borrow money, so |
| rate, it is an average of all of these rates together, not | | | | business expansions, home buying and other activities |
| one particular rate. | | | | that involve borrowing money are more attractive. The |
| What is the Difference between the Federal Funds | | | | downside of a low interest rate is that it is low across |
| Rate and the Discount Rate? | | | | the board, if interest rates are low to borrow money, |
| Another way that a bank can replenish its cash | | | | they will be low as a return in a savings account or |
| reserves is by borrowing directly from the FDIC, this is | | | | certificate of deposit. |
| called borrowing from the discount window, and the | | | | There is no way for the individual consumer to affect |
| interest rate that is paid is called the discount rate. The | | | | the federal funds rate, but by watching it, you can get |
| discount rate is higher than the federal funds rate. | | | | a feel for the direction that the economy is traveling in. |
| The reason that the discount rate is higher than the | | | | Banks often borrow money so that they have enough |
| federal funds rate is because the federal government | | | | cash reserves for large projects, and an increase in |
| wants to encourage the banks to borrow from each | | | | overnight borrowing can point to a thriving economy. |
| other. Only when a bank has no better option do they | | | | Likewise, flat levels of borrowing can mean that banks |
| borrow from the discount window. While the federal | | | | are only borrowing to replenish their demand reserves, |
| funds rate is a comparative average of all the interest | | | | not to fund new loans or investments. |