Interest Rates Explained

Interest rates can vary because of different factors. However, the basis of where interest rates are derived from fall in three categories. Interest rates categories are: What you pay, What the Bank pays, and What it pays you.

What you pay — Interest rates that you pay come in the form of interest rates on loans, credit cards, mortgages and the like. This interest rates is loose based on the Fed Fund and Prime Rate. Banks usually have their own calculation to decided what the interest rate for a given product will be. However, the Fed Fund and Prime rate is always part of that equation. Banks stay competitive when they adjust their equation differently from other banks and financial institutions. Also included in factors that contributed to what you pay in interest is you. Included in this category of interest is risk. Risk equals your credit rating and this accounts for why some people pay more than others.

What the Bank pays — Banks loan each other money, all day every day. The interest rates charged to other banks is the Fed fund. In the news currently you have been hearing that the Fed fund interest rate has been falling. The Feds do this to control the market. When the Fed fund is low, the result is a lower interest rate on what the bank pays you, increase in bank fees and other ways to compensate for a low Fed fund.

What it pays you — This interest rate is the rate of return on your investments with banks. Investments with banks could be CDs, money market accounts, and/or saving accounts. Again, this interest rate is make up from a calculation that the bank does. However, when the fed fund is low you will usually see a decrease in the interest rates the bank pays you.

So now you know all about interest rates.

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