Federal Reserve Prime Rate
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The federal reserve prime rate can have a far-reaching effect on economic issues and the household budgets of many consumers. Even so, many people find it difficult to understand the up and down movements of interest rates. They sometimes aren't sure exactly why economists, legislators, and news commentators anxiously await the announcement of what fraction of a percentage point the Federal Reserve has raised or lowered its rate. But these movements and percentage point fractions are catalysts for both institutional and international borrowing and lending, then filter down to influence interest rates on consumer borrowing and even investment returns. This is why it's so important to have at least a basic understanding of economic and financial issues. When consumers make financial decisions for their families, it's helpful to understand how those decisions can be influenced by governmental economic factors such as the federal reserve prime rate.
The United States Federal Reserve Board is an independent government agency that was created by legislation that President Woodrow Wilson signed into law in December 1913. This entity is made up of seven members, known as the Board of Governors, who are appointed by the President and confirmed by the Senate. The members serve single fourteen-year terms that are staggered to ensure some continuity on the Board, which is commonly referred to as the Fed. Many people believe that the federal reserve prime rate is decided by the Fed, but this isn't accurate. The Fed controls two other important rates, the federal funds and discount rates. Banks are required by law to have a certain monetary amount in reserves. If a particular bank goes below that amount, then money is borrowed from other banks to reach that required level. The interest that banks pay to each other for the money they borrow is called the federal funds or overnight rate. When the banks borrow from the Fed instead of other banks, they pay what is called the discount rate. Because the Fed prefers the banks to borrow from each other instead of borrowing from the Fed, the discount interest is usually higher than the federal funds interest. A federal reserve prime rate isn't actually controlled by the Fed.
Prime rate actually refers to the interest that banks charge their very best and most reliable customers. This interest percentage may vary from one lending institution to another though probably not by much. It can also fluctuate depending on various factors. Naturally, if a company can borrow money at the lowest possible interest, then the savings in debt repayments can be passed along to customers or add to its profitability which can be passed along in the form of dividends to stockholders. Businesses are very interested in knowing what interest percentage banks are charging the best customers so that they can borrow money as close to that same percentage as possible. Because the prime rates for banks are very close to each other, a single percentage is commonly referred to as the federal reserve prime rate. This percentage is important to the economists, legislators, the business community, and consumers because so many loans and investments are affected.
In recent years, many potential homeowners applied for and were approved for adjustable rate mortgages (ARMs). Though the initial monthly payments were affordable for these homeowners, the upward adjustments in the interest rates created problems with the household budgets. The rates increased because they were tied to what people commonly refer to as the federal reserve prime rate. When it increased, so did the interest on the mortgage. Even a one percent increase could mean a mortgage payment that is now hundreds of dollars more than the initial payment. For many families, this has been a crushing financial burden which has underscored an important truth: "The rich ruleth over the poor, and the borrower is servant to the lender" (Proverbs 22:7). As people began losing their homes, both the federal government and mortgage holders are looking for solutions to resolve this national calamity. Additionally, many home equity lines of credit (HELOC) are also tied to the prime rate so that even consumers with more traditional fixed-rate mortgages find the minimum payments on HELOC debt rising and falling depending on federal economic factors.
To add to the household financial burden, many consumer credit cards are tied to this same federal reserve prime rate. As the percentage point creeps up, even if only by a fraction of a percent, the interest rates on these credit cards also rise. Minimum monthly credit card payments increase and that can place an additional burden on an already stressed household budget. With more money going to increased mortgage/HELOC and credit card payments, less money is available for other consumer spending. A downward spiral begins where retailers are receiving less revenue which may result in job layoffs. Consumers can protect themselves, though perhaps not totally, from the effects of the ups and downs of the federal reserve prime rate by becoming economically literate and making wise financial decisions. Money experts can provide consumers with important information on the benefits of fixed-rate mortgages, the best use of a home equity line of credit, and the folly of carrying balances on credit cards. Those who find themselves in a financial mess should seek wise counsel on getting out of debt and investing in an emergency fund so that better financial decisions can be made in the future. Though perhaps no one can be totally immune to the shifting lending rates, a household with a fixed mortgage payment, little consumer debt, and invested savings will make it through tough economic times.
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