Why Do Interest Rates Matter? (2024)

FAQs

Why Do Interest Rates Matter? ›

Interest rates influence borrowing costs and spending decisions of households and businesses. Lower interest rates, for example, often encourage more people to obtain a mortgage for a home or to borrow money for an automobile or home improvements.

One way that interest rates matter is they influence borrowing costs. If interest rates are lower, that will encourage more people to take out a mortgage and purchase a house, purchase an automobile, or take out a loan for home improvement, those kinds of things.

The federal funds rate is one of the Federal Reserve's key tools for guiding U.S. monetary policy. It impacts everything from the annual percentage yields you earn on savings accounts to the rate you pay on credit card balances, which means the fed funds rate effectively dictates the cost of money in the U.S. economy.

Key takeaways

Higher interest rates can make borrowing money more expensive for consumers and businesses, while also potentially making it harder to get approved for loans. On the positive side, higher interest rates can benefit savers as banks increase yields to attract more deposits.

Nevertheless, some sectors benefit from interest rate hikes. One sector that tends to benefit the most is the financial industry. Banks, brokerages, mortgage companies, and insurance companies' earnings often increase as interest rates move higher because they can charge more for lending money.

The term federal funds rate refers to the target interest rate range set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. The FOMC is the policymaking body of the Federal Reserve System.

Even people with good credit scores make mistakes, and a bank may charge a penalty APR on your credit card without placing a negative mark on your credit report. Penalty APRs typically increase credit card interest rates significantly due to a late, returned or missed payment.

Key Takeaways. Interest rates and bank profitability are connected, with banks benefiting from higher interest rates. When interest rates are higher, banks make more money by taking advantage of the greater spread between the interest they pay to their customers and the profits they earn by investing.

Higher interest rates help to slow down price rises (inflation). That's because they reduce how much is spent across the UK. Experience tells us that when overall spending is lower, prices stop rising so quickly and inflation slows down.

How does the Fed control inflation? The Federal Reserve seeks to control inflation by influencing interest rates. When inflation is too high, the Federal Reserve typically raises interest rates to slow the economy and bring inflation down.

Will mortgage rates ever be 3% again? ›

Lawrence Yun, chief economist at the National Association of Realtors, even told CNBC last year that he doesn't think mortgage rates will reach the 3% range again in his lifetime.

Besides loans, banks also invest in bonds and other debt securities, which lose value when interest rates rise. Banks may be forced to sell these at a loss if faced with sudden deposit withdrawals or other funding pressures.

It depends on your personal situation. If you're comfortable with the amount of money you'll pay on a mortgage with a higher interest rate, buying may be a good choice. Consider your finances before making a decision and only buy a home if you're sure you can afford it.

The Fed raises interest rates to slow the amount of money circulating through the economy and drive down aggregate demand. With higher interest rates, there will be lower demand for goods and services, and the prices for those goods and services should fall.

With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates. Central bank monetary policies and the Fed's reserver ratio requirements also impact banking sector performance.

Lower rates also can encourage businesses to borrow funds to invest in expansion, such as purchasing new equipment, updating plants, or hiring more workers. Conversely, higher interest rates can restrain such borrowing by consumers and businesses, which can prevent excesses from building in the economy.

Interest is essentially a charge to the borrower for the use of an asset. Assets borrowed can include cash, consumer goods, vehicles, and property. Because of this, an interest rate can be thought of as the "cost of money"—higher interest rates make borrowing the same amount of money more expensive.

Looking for stocks in utilities, energy, healthcare and other blue-chip defensive stocks could result in dividends as well as potential appreciation. Growth stocks: Depending on your risk tolerance, growth stocks might make a good choice with Fed rate cuts ramping up.