Factors affecting interest rates for savings accounts, loans, credit cards and other financial products include the health of the U.S. economy, supply and demand and your own individual credit score, but decisions made by the Federal Reserve are among the biggest influences driving the direction of rates. Even though interest rates have crept upward this year, rates remain historically low.
The Federal Reserve Open Market Committee — currently chaired by Janet Yellen — uses monetary policy to keep the economy running smoothly. This includes adjusting the federal funds rate, which is the overnight interest rate most banks charge each other.
When the economy is relatively weak, the Fed keeps interest rates lower to encourage banks to lend, companies to borrow and the economy to grow. As the economy gets stronger and more robust, the Fed raises interest rates so the economy won’t overheat and to keep inflation in check.
The federal funds rate influences the prime interest rate, or the rate banks give to their best customers. This, in turn, helps determine interest rates on various types of loans, including:
- Credit cards
- Car loans
- Small business loans
- Home equity lines of credit
- Term loans
Here are seven key things that impact interest rates:
1. The Fed Funds Rate Is Low
When newscasters say the Fed is poised to raise interest rates, they’re referring to the federal funds rate, the overnight interest rate member banks charge one another. When the Fed makes a move, the entire economic community is watching.
The federal funds rate directly and indirectly impacts many types of interest rates. Despite several rate hikes this year, the federal funds rate is low, which means other interest rates also are low.
When the Fed raises the federal funds rate, you can expect higher interest rates for borrowing and saving in the near future. As interest rates rise, be a wise consumer and examine the APR vs. the interest rate to make sure you’re getting the best deal.
The Fed uses information about the money supply to analyze the current economy’s financial strength. Such information is used in monetary policy decisions including whether to raise or lower interest rates.
Personal loan interest rates might be at a certain level due to the interaction between the supply and demand of the money supply. In basic economic theory, the price of a commodity — in this case, the commodity is money — is determined by the interaction of supply and demand.
Think of interest rates as the “price” you pay for money. When interest rates are high, borrowers pay more for money and demand less of it, thereby reducing the money supply.
The Fed can influence the direction of the money supply by raising or lowering interest rates. Here’s how it works:
- The Fed might increase the money supply by lowering interest rates if the economy is growing slowly.
- The Fed might decrease the money supply by raising interest rates if the economy is growing more rapidly.
Fed decisions can have a big impact on mortgage interest rates, too. The federal funds rate influences the 10-year Treasury bond interest rate. When the Treasury bond interest rate increases, mortgage rates also tend to go up, according to a report by Zacks research.
As a result, some homebuyers will find it more difficult to afford that dream home they’ve been eyeing. After closing costs, the extra expenses don’t end. Higher interest rates mean more expensive payments.
Another factor that has a major impact on your mortgage and other borrowing rates is your creditworthiness. Borrowers with higher credit scores qualify for lower interest rates because lenders view them as less of a credit risk. That’s why it’s smart to regularly check your credit.
4. Unemployment and Inflation Are Driving Fed Policy
The employment situation summary, released by the U.S. Department of Labor’s Bureau of Labor Statistics, gives a comprehensive view of the nation’s employment picture. Lower unemployment also suggests a stronger economy that is better able to withstand an interest rate increase, which helps support a Fed decision to increase interest rates.
The Producer Price Index typically offers the first clues of impending inflation, another key driver for interest rates. The PPI measures prices in the economy and can be found at the Bureau of Labor Statistics.
Fed interest rate policy aims to keep inflation at reasonable levels and uses the PPI as a guide when setting interest rate policy. Inflation rates have been very low in recent years, which is another reason the Fed hasn’t felt compelled to raise the federal funds rate.
5. Gross Domestic Product Has Been Tepid
Gross domestic product also has an impact on Fed interest rates. The GDP — reported quarterly by the Bureau of Economic Analysis — measures the market value of all goods and services produced in the U.S. during a particular time period. The GDP is frequently used to measure the country’s wealth and how fast profits are growing. In aggregate, the GDP measures the economic growth and health of the country. Depending on this measure, the Fed might adjust interest rates up or down.
In recent years, GDP growth has been tepid, but picked up steam in 2017. The Fed raised interest rates twice in 2017 and will raise interest rates even higher if the health of today’s economy continues to improve.
6. Consumer Confidence Impacts Interest Rates
The monthly Consumer Confidence Survey — reported for the Conference Board by Nielsen — examines a sample of Americans’ feelings about business conditions, employment and financial expectations, consumer spending and economic growth. Stronger consumer confidence correlates with greater willingness to spend, which helps grow the economy.
This number can be volatile, but a more robust Consumer Confidence Survey result suggests the economy is strong enough to withstand a hike in interest rates. Confident consumers might expect to see higher interest rates.
7. Your Personal Credit Profile
Your credit score measures how responsibly you borrow and repay money. The FICO score is based on a model created by Fair Isaac Corporation and is the most commonly used credit score. According to Experian — one of the three major credit reporting agencies — this single number takes into account several factors:
- Total debt
- Types of debt and credit accounts
- Number of late payments
- Percent of available credit used
- Age of accounts
Experian reports that most credit scores range from 600 to 750, and a score above 700 is considered good. The better your credit score, the lower interest rate you can expect to pay when borrowing money. Before deciding where to get a loan, shop around because financial institutions offer different rates.
Of course, the market range of interest rates initially determines the actual range of available interest rates. For example, when 30-year home mortgage loan rates range from 3 to 4 percent, borrowers with a higher credit score can expect to garner a mortgage interest rate closer to 3 percent — though the type of mortgage loan will also impact the interest rate.
Ultimately, anyone with a bank account or recent loan has noticed that interest rates are creeping upward. Appreciate how interest rates work. Keep your eye on the economy, the Fed and your credit profile to understand how federal government policymakers drive interest rates today, and what rate you can expect to receive both now and in the future.