Understanding bank rates

- [Narrator] When you're following the news, you might come across an article that the Fed lowered interest rates. It's something the news often reports on. This may be a good opportunity to revisit your finances and make informed changes such as refinancing your mortgage. That's why understanding the Fed's role in the banking system is important. The Fed not only controls the banks and ensures the health of the U.S. financial system, but it also sets interest rates which help determine the level of economic growth, inflation, and unemployment across the country. In case you're not sure what interest rates are, interest rates determine the cost to borrow money. When you borrow money from a bank or use a credit card, interest rates determine how much you have to repay the organization. The chairman of the Federal Reserve heads up the Fed's controlling body called the Bank of Governors, and acts as the public leader of an organization that most Americans don't really understand, but which all Americans are influenced by. The Chairman of the Federal Reserve is often referred to as the second most powerful person in the country behind only the president, who's the one that appoints the chairman. Today, Jerome Powell is the chairman. The primary tool the Fed uses to set interest rates is called open market operations. Open market operations, or OMOs, are the purchase and sale of securities in the open market by a central bank. Basically, the Fed buys and sells U.S. government debt when they set the interest rates where they want them to be. If you'd like to learn more about the Fed, their website, federalreserve.gov is a great place to start. Now, you may be wondering how banks make money if they're always borrowing money from the Fed. In order for a bank to make money, the bank must charge more for the money it loans out to people then what it pays on the money it accepts from savers and the Federal Reserve. For instance, a bank might lend money at 5%, but borrow money from the Fed at 2%. The difference between these two is the bank's profit, also called the net interest margin. When you're borrowing from the bank, it's important to consider two significant rates, the prime rate and that net interest margin. The net interest margin is made up by the difference between what the bank charges and what it pays, and it's a critical variable that drives the bank's profit levels. The prime rate is the lowest rate that the bank charges its very best customers. The prime rate and the bank's net interest margin rates drive all of the other rates the bank charges, including CDs, home loans, student loans, savings, HELOCs, et cetera. Let me show you a real-world example. I'm here at the website for a regional bank that I'm familiar with called Webster Bank. Now, Webster Bank's website of course, is unique to them, but most banks have a website that's similar to this. But if you go check out your bank's website, you should find areas where they'll tell you about the rates that they pay on things like savings accounts. In the case of Webster Bank, right now, Webster Bank is paying rates of as much as 0.3% per year. That's what the a APY means. That's the annual percentage yield, which is essentially just the rate of return or rate of interest on your money. So remember that 0.3%, that's what Webster will pay you. Now, if you borrow money from Webster, how much do you pay? Well, if we go over to the borrow tab, we'll just look at a fixed rate mortgage for say, a home. In this case, Webster will charge you 3.96%, just under 4% for say, a standard 30-year fixed mortgage. Now, of course, this will vary based on a variety of factors, but it gives you a good idea of what I'm talking about. Webster is charging you more for money you borrow from them than they will pay you if you lend money to them by opening up a savings account. That's how a bank like Webster and every other bank out there makes money. Now, it's important to distinguish between this APR shown at the end, versus what's called a simple interest rate. The APR stands for annual percentage rate. Essentially, it means that you are charged money based on not only the amount that you've borrowed, but any interest that accrues over time. If you fail to pay off your loan, your payments will be higher in the future. It's the compounding effect in your interest rate. The same thing holds true on the savings side. The more money you have as a result of interest payments you've earned in the past, the more money you'll earn in the future, and that's how banks operate. Now, you should have a good handle on what you need to consider. Make sure you are making the right choice for the product and rate that is right for your particular needs.