We keep hearing that “interest rates are dropping,” and that’s exciting news for anyone eyeing a new home or looking to finance a big purchase. But then, when we actually check loan rates, they don’t seem to be falling—in fact, some are even going up. So, what’s going on? While terms like “federal funds” and “rate markets” might sound complex, we’re here to clear up the confusion and explain why different rates move in different directions—and what it all means for you
whether you’re a business owner or a consumer searching for low rates on loans or high returns on investments.Understanding Interest Rate Types
First, it is important to know that there are different types of interest rates: short-term rates (from one day to 30 days) and long-term rates (up to 30 years or more). Most consumers encounter long-term rates for things like mortgages or personal loans.
When we hear in the news that interest rates are going down, this usually refers to short-term rates controlled by the Federal Reserve. Longer-term rates, which affect things like home loans, are set by the market. The government has no direct control over these.
Rates Controlled by the Federal Reserve
When you hear the media saying rates are expected to drop, this generally means that the Federal Reserve is likely to vote to decrease a specific rate, known as the “fed funds rate.” This rate controls what banks charge each other to borrow money overnight. However, it does not directly control the rates consumers pay for things like car loans, mortgages, or even refinancing. Each of these rates is determined by the market, based on consumer demand and economic outlook.
Why Do Banks Lend Money to Each Other?
Banks have always lent money to one another to balance daily cash needs. Large withdrawals or deposits by customers make it difficult for banks to predict exactly how much cash they need each day. By borrowing from each other overnight, banks can cover any gaps and ensure they meet customer needs without delay. This overnight lending involves charging each other interest, a rate which the Federal Reserve controls.
How Does This Affect Consumers?
Lower overnight rates make it cheaper for banks to lend money to one another, a savings they pass on to customers through reduced costs on certain loans like credit cards, home equity lines of credit (HELOCs) and other lines of credit. But other rates, such as for home loans, may actually stay the same or even go up. For example, despite recent rate cuts by the Fed, home loan rates have been on the rise over the past six weeks.
Why Are Home Loan Rates Increasing?
Home loan rates generally increase when financial markets believe the economy is growing. Rates tend to drop when there’s concern about an economic downturn or recession. Recently, economic signals—like strong employment and spending data—have led financial experts to believe the economy is unlikely to enter powerful recession, despite previous concerns. As a result, long-term rates, including home loans, have increased.
When financial markets feel confident about economic growth, they make investment decisions that can lead to rising interest rates. If the outlook shifts to a more pessimistic view of the economy, these rates tend to decrease. These predictions are shaped by various reports and data sources, such as job growth, housing sales, inflation trends, and general consumer activity.
How Do Rate Changes Impact Business Owners?
For business owners, the difference in rate trends can create mixed results. The overnight lending market—affected by the Fed’s rate cuts—might affect line of credit rates. However, long-term borrowing rates for capital investments (like land or equipment purchases) are driven by market demand and have been unstable, despite the Fed’s cuts. Business owners, therefore, may find the cost of financing short-term needs dropping, while long-term loan costs rise.
What’s Happening with Deposit Rates?
Deposit rates are currently in an unusual pattern. Short-term certificates of deposit (CDs) are paying higher rates, while savings and money market account rates have likely peaked and may gradually follow the Fed’s rate cuts. This means you may see higher returns on short-term CDs (3-6 months) compared to longer-term CDs (12 months or longer).
In Summary
When you hear about interest rate decreases in the news, remember that this typically applies to short-term, overnight rates between banks. Longer-term rates affecting mortgages, personal loans, and other consumer financing are determined by the market and can move in a different direction. If you’re looking for lower rates on a line of credit or credit card, the Fed’s rate cuts are a positive sign. But for long-term financing, such as mortgages, rates are based on broader economic conditions and may not decrease just because of a Fed rate cut.