Understanding How Interest and Dividend Rates Are Impacted by the Federal Reserve
If you’ve been house hunting recently, you’ve probably noticed the competitive market due to the extremely low rates. As interest rates drop, the same goes for Annual Yield Percentage (APY), which impacts the amount you are earning back on your savings. Understanding the effect these rate changes have can help you navigate the financial world. Here’s a breakdown of what this all means.
There is one central bank for the United States — The Federal Reserve, also known as the Fed. One of the many roles of the Federal Reserve is to establish a strong, yet contained economy. The interest rates for loans at financial institutions are influenced by the Federal Reserve’s decisions to raise or lower rates.
For example, as the Federal Reserve raises interest rates, consumers are typically charged more in interest to borrow money for loans. Rates rise for auto loans, home loans, credit cards and personal loans. That means the total cost for loans goes up. This often discourages people from borrowing because they don’t want to pay a lot of money in interest for a new home, vehicle or any other type of loan.
Financial institutions pay you to keep your money in savings, and sometimes other accounts. Dividend or interest rates often increase or decrease in response to changing loan rates. This means if the Federal Reserve raises rates, a loan will usually have a higher interest rate. However, in return, people may receive better rates of return for the money they keep in savings accounts. This often encourages people to save more aggressively because of the potential to earn more on savings.
Typically, the Federal Reserve raises interest rates when the economy is stronger and more people have jobs with the goal of avoiding inflation. The assumption is that people who want loans will be able to afford higher interest rates and are less likely to borrow unnecessary money because it will cost more. Additionally, people will often save more money during this time and create more individual financial stability. Rates will generally be lowered when the economy is slower in an effort to encourage more people to take out loans and spend money.
In summary, when rates are raised or decreased, this impacts both loan and savings rates. Generally, higher rates indicate a stronger economy with the goal of encouraging saving, while lower rates are sign of a weaker economy to help aid spending abilities.