What Controls Interest Rates.

 When people wish to purchase something such as a car or house, they often shop around for the best deal they can.  Sometimes it requires a higher down payment to get the better interest rate while other times, its a special designed to get rid of inventory.

Historically, interest rates have been all over the place from lows of 1% to 12 or 13%.  When discussing interest rates, there are three different ones which effect current rates.  One is the Prime rate, another is the Federal Fund rates, and the last is the Discount interest rate.

The Prime rate is actually the federal interest rate, usually tied to mortgage rates, money market accounts, and CD's or Certificate of Deposits.  This is the rate that financial institutions use to set interest rates on loans.  It is also tied to variable rate credit cards and loans so if the prime rate goes up, the interest rate associated with these vehicles also goes up.  Over the past 100 years, prime rates have gone from 1% to an all time high of 21.5% in 1980.

The Fed Fund rate is the rate banks pay to borrow money from other banks.  This happens if their minimum amount of money in reserves falls below a certain amount based on the amount of money they have from customers.  When this rate goes up, there is less money available for bank to bank loans.

Originally, in the 1920's, bank to bank loans were based on stock exchange call loans rate.  Unfortunately, when the crash of 1929 hit, the call loans stagnated so rates stayed at 1% through the depression and 1930's.  When World War II hit, rates were kept low due to the war but once the 1950's arrived that Federal Fund market set bank to bank loan rates. The rates rose to over 16% in 1981 before declining.

Finally, the Discount Interest Rate is the rate banks are charged to borrow money from the Federal Reserve for a short time.  This rate is set by the Federal Reserve banks and falls into one of three classifications - primary credit, secondary credit, and seasonal credit.  Each has its own credit rate and all loans are secured.

These are the three main influences on regular loans but there are other things that influence the interest paid on savings accounts, credit cards, etc.  Tomorrow I'll go into those.  I've taught calculating interest using simple and compound formulas but I've never known how certain rates were set.

Let me know what you think, I'd love to hear.  Have a great day.