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What is the Federal Funds Rate?

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The Federal Funds Rate is a target interest rate that is set by the Federal Reserve. It directly affects the interest rate that is charged to a bank when borrowing from another bank. Banks are required to keep a certain percentage of funds in reserve in Federal Reserve banks. When funds fall below the reserve percentage they must borrow overnight to bring their reserves up to the required percentage. If a bank has more than the required reserve then they can lend the money to other banks. When the Fed changes rates what they are doing is implementing monetary policy which helps promote national economic goals. What this does is affect how available money is in the economy. When the rate is low money is “cheaper” and banks are more likely to lend money out to businesses so they can grow. When the rate is high banks are less likely to lend which leaves less money available for businesses to borrow.

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It seems stories on the economy and the Feds are in the news everyday. Because of that, it seems this blog and news sources often talk about the Federal Funds rate. But what does the federal funds rate do, and how does it impact mortgage rates? To answer those questions… The federal funds rate has a direct impact on the rate at which banks borrow and lend money. The Fed rate determines prime rate, which follows along with the federal funds rate. For instance yesterday, the Fed rate dropped from 4.25% to 3.5%, and prime rate followed by dropping from 7.25% to 6.5%. Banks use prime rate to determine rates for 2nd mortgages, home equity lines of credit, credit cards and car loans. While this is helpful for 2nd mortgages, 1st mortgages generally suffer. I know what you are thinking — but why? There are some reasons, and I will list them below. First remember mortgage rates are determined by the mortgage-backed securities bond market. When more money is invested into bonds, bond prices go u

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Depository institutions actively trade reserves held at the Federal Reserve among themselves, usually overnight. Those with a surplus balance in their accounts transfer reserves to those in need of boosting their balances. The benchmark rate of interest charged for the short-term use of these funds is called the federal funds rates. The target for the federal funds rate is set by the Federal Open Market Committee. For more information on the federal funds rate, go to www.federalreserve.gov/fomc/fundsrate.htm.

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