I remember back in high school, first learning about what interest was. This was during a very simple math class. And, no, it wasn’t that long ago!
“Interest,” my teacher started to say as she looked over the class, “is simply the charge that banks make you pay during a loan.”
Actually, it made sense. I borrow money from a bank. I then owe the sum of the loan plus a fee for being able to borrow the money.
There was one issue I had…
“Mrs. Rodgers… how do banks figure out what the interest rates are for loans?”
And there it is, folks. The question that has boggled many consumers’ minds for decades.
“Well, it is based on the Fed Rate.”
Okay…what is the Fed Rate? And, how does this impact my loans and refinancing? And what is the difference between the Fed Rate, an APR and my loan interest?
Lots of questions!
Let’s get to some answers.
“Hi, I would like to refinance all of my loans to 0%”
You and me both!
At First Choice, we have had a lot of requests like this over the past few weeks. The Federal Reserve made the announcement to reduce the Fed Rate to 0% to 0.25%, and we have gotten calls, emails and Bat-signals more or less saying similar things.
But, what does the Fed dropping rates really mean to you?
The Fed Rate is actually a bank-to-bank rate that at times has a direct and an indirect influence on the rates you pay as a consumer. So, technically, while the Fed Rate is low, lower and even lower still, it does not 100% translate into lower mortgages rates, auto loans and personal loan rates.
Here is what I mean…
Everything tends to go in cycles in the financial industry. This is actually a blessing in disguise.
Let me explain this one…
When interest rates are down, or the Fed Rate is low, the cheapest way to borrow money is to borrow it on a variable rate component. The idea of variable rate is often expressed as “Prime +” something. However, as the Fed Rate rises, many consumers seek the more predictable Fixed Rate model.
At First Choice Federal Credit Union we have always been a proponent of Fixed Rates.
There are many reasons for this, but the biggest is that we like debt with a fixed payment and a fixed term. When you add variability into the equation it MAY be cheaper in the short-term, but adds more cost in the long-run.
Our motto is “simpler is better”.
When the Fed Rate is down some credit cards and some variable rate real estate loans (like lines of credit) payments could go down. This could save you money in the short-term.
However, with less money required, it doesn’t reduce your principle. As the Fed Rate rises, you have not reduced your obligation, so you will owe more in the long run.
The Fed Rate is a bank-to-bank rate.
This means it influences what banks can get in investments. This is why it has such an immediate impact on savings rates.
If banks are not able to invest money in short-term or long-term investments with a guaranteed return, they are not able to offer that to their customers (or members in our case).
The first casualty you will find after the Fed Rate lowered its rate is the CD market. It essentially became impossible to find a decent CD rate practically overnight.
This kind of cycle, lowered Fed Rate, certain markets’ rates disappear, encourages banks to put that money that they would otherwise invest out in loans. If they are unable to make money via investments, they will have to make money via interest earned by lending it out.
This lending practice is significantly riskier and at times the Fed has to prompt institutions to do this.
How is First Choice “different”
The above example is not the case at First Choice Federal Credit Union.
We lend the money out that you entrust to us to our members at already low loan rates.
We are able to do this because we keep our expenses down, and put that money out to you. It is our feeling that when we do that and treat you right, you will come back.
We understand that we could make money investing deposits. But, that doesn’t put the money in the place where it does the most good – in your pockets, taking care of your needs.
Our Promise To You When It Comes To Lending, The Fed & More
We are confident that if you shop around, you will find that we offer great rates to our members. And if you find something better, please let us know.
Yes, we do make money off of lending. We make money commensurate with our risk.
But, we are not motivated by profit.
We are, instead, motivated by service to our members and the sustainability of our organization to continue to meet the needs of our people.
What does the Fed Rate being at 0% mean to you?
The same things that it means when the Fed Rate is much higher:
Your credit union is here looking out for your best interests, and doing our best to deliver you the best rates right when you need them most.
To find out more about loans, how it can impact future loans and your current First Choice loans, give us a call at (724)652-8393.