How is the interest rate calculated?

Sam

Mortgage interest rate is the percentage of the principal amount that is paid back to the lending institution on a monthly basis. The interest rate is determined by considering the following factors.

Federal Funds Rate:
Interest rates fluctuate depending upon the amount of money available in the national reserve. As the available funds increase, the Federal Funds Rate comes down. The banks which borrow from the Federal Reserve also register a slowdown in the Prime Rate (the standard rate offered by banks while lending money). But the Federal Funds Rate increases when the reserves decrease and demand increase.
Consumer Price Index:
The Consumer Price Index is a measure of what consumers are paying for various goods and services at stores and retail outlets. However, it does not include food and energy prices. It is an important factor that indicates the rate of inflation. High inflation implies high interest rates and low inflation indicates that interest rates will come down.
Employment Cost Index (ECI)/Average Hourly Earnings (AHE):
The ECI reflects the changes in the employee wages, salaries and benefits. The AHE reveals how the wages vary from one month to another. These factors influence the interest rates because increasing labor costs often force businesses to raise prices. This compensates for the rising costs thereby resulting in inflation.
Gross Domestic Product:
The Gross Domestic Product is a measure of the nation's total economic output for every 3 month period. When growth is too strong, the demand for goods and services exceeds that of supply. Businesses therefore charge more thereby leading to inflation.
Advance Retail Sales:
Retail sales act as key driving force in our economy. The Census Bureau compares the sales at different retail stores so that it can get an idea about consumer spending power which depends on inflation.
New/Existing Home Sales:
The data on new or existing home sales reflect the consumer demand for homes and loans. It is this demand that influences the interest rate charged on the mortgage.

Guest

howoften does the fed review the prime lending rate

Guest

Hi,

Usually the Federal Open Market Committee or FOMC meets eight times each year, where the target is set for federal funds rate.

And the other rates such as the Prime Rate, derive out of this base rate.

Thanks
Jenkins

colin · Posted: Wed Aug 23, 2006 5:15 pm Post subject:

Hi,

I would like to add some more points on how the federal funds rate gets calculated.

When there are inflationary trends in the market, FOMC slows the economy by increasing the rate.

This makes borrowing expensive and slows the economic activities. On the other hand if it is necessary to stimulate the economy, then the rate is brought down to some extent, making it affordable for banks to lend money and for general people to borrow..

The changes in these rates have a significant effect on all other long and short term rates.

Colin

All times are GMT - 7 Hours

Page 1 of 1