What Is the Fed Rate and What Does It Mean For You?

Personal Finance

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All over the news, headlines read that the Federal Reserve rates are at an all-time low recently, but what does it mean for you? 

Understanding fed rates and how they impact banking, borrowing, and saving can help you plan your finances. 

What is the Federal Reserve?

Congress created the Federal Reserve System in 1913 to be a central bank for the United States in response to financial crises of the early 20th century. The Federal Reserve—the Fed for short—is made up of 12 banks, each responsible for a regional division of the country. 

The board of governors and Federal Open Market Committee make decisions for the Fed. 

The responsibilities of the Federal Reserve are to:

  • Oversee national monetary policy.
    This includes things like determining credit conditions in our economy to  improve employment and keep pricing and interest rates steady.
  • Direct and regulate banking institutions.
    This allows the Fed to make sure U.S. banks are safe and protect American consumers.
  • Ensure financial system stability.
    One of the Fed’s main responsibilities is managing inflation, or the devaluation of currency over time.
  • Administer financial services.
    This includes support to the national payments system and the U.S. government.

What is the fed funds rate?

The Fed has a rule that banks must keep enough cash on hand to open for business every day. 

This rule means banks can run steadily and don’t hand out every dollar in their vault. 

If a bank is low on cash, they can borrow from another bank. 

When a bank lends money to another bank, the borrower is charged the fed funds rate for the loan.

Why does the fed rate exist?

The fed rate plays into how federal funds are used to control the nation’s interest rates. By requiring banks to have cash on hand, the Fed ensures that customers can always get money from their banks. 

The goal is to keep inflation low and to do that, the Fed raises the fed funds rate. 

Inflation means the dollar is worth less.If inflation rises unexpectedly, basic needs (housing, food, utilities) suddenly become more expensive, and the economy suffers. 

Keeping the inflation rate low and stable means people can reliably buy what they need to and the economy stays healthy.

What does this mean for me, as a consumer?

The fed rate sets the bar for credit rates.

The borrow rates you get on your credit cards, mortgages, and other loans are based off of the fed rate.

This means that the interest you repay the bank for your car loan, credit card payments, and home mortgage is all affected by the fed rate.

What’s a low fed rate? What’s high?

In times of crisis, like during the COVID-19 pandemic, the Federal Reserve lowers the target for the federal funds rate. 

Money is freed up and easier to borrow when Americans have less to spend. 

As of late June 2020, the Federal Reserve’s fed funds rate is 0.25% (up from nearly 0% earlier in the pandemic). The last time the fed rate was this low was during the 2008 financial crisis, and the Great Depression in the 1930s before that.

Does this affect financial products?

Changes to the fed fund rate have downstream effects on financial products like high-yield savings accounts

While the Fed rate is complicated, the effects most people will notice are pretty simple. Lower fed rates mean that banks set lower interest rates, which means if you’re saving money you’ll probably make less on interest. But, if you’re looking to borrow money, you’ll probably be paying a lower interest rate.

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