Understanding the Fed Fund Rate

Sep 8, 2022 | Finconomics 101, No Bull Economics

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The Federal Funds Rate is the short-term interest rate at which depository institutions (commercial banks, savings & loans, credit unions) lend overnight to each other within the Federal Reserve system. The Fed meets 8x per year to decide on the appropriate rate and banks must keep a certain percentage of their customers’ deposits on reserve at one of the 12 regional Federal Reserve banks – lending money back-and-forth to maintain an appropriate reserve level (either charging or paying the Federal Funds Rate as interest on these loans). In turn, the Federal Funds Rate influences the Prime Rate which is used as an index for many short & medium-term loan products (credit card, student loan, car loan, business loan or home equity loan). The Prime Rate is typically set by calculating the Federal Funds Rate +3% (5.5% currently). While mortgage rates track the Prime Rate, they also track the 10-year Treasury rate which has been hovering at just over 3%. In any case, average mortgage rates have jumped from 3.1% at year-end 2021 to 5.2% during 2Q22 (in-line with a +2% increase in the Federal Funds Rate during that same period).

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