BOULDER – As everyone in the world of home buying knows, interest rates go up and down. The Federal Reserve raises these rates to help keep inflation from growing out of control. Inflation is determined by how fast the cost of a good or product rises; it varies by year, but it helps dictate the value of any given item. In 1950, for example, the average cost of a gallon of milk was $.82; now it’s around $3.50.
Increasing interest rates encourages consumers to save. This slows down the economy and helps keep the American dollar strong. When interest rates are low, the opposite happens: people loosen their purse strings, buy more, and the value of the dollar decreases.
In a fractional-reserve banking system, interest rates are inversely related to inflation. This gives central banks the power to slow inflation if it begins to increase too quickly. Supply and demand, naturally, play a role, as well; it is economics, after all. When the money supply increases, prices tend to follow and they climb higher. Inflation corrupts the value of money – from ones to twenties to hundred-dollar bills, the dollar becomes less potent.
When interest rates decrease, both banks and individuals request more loans. With each loan granted, the amount of money in the fractional-reserve banking system increases, ultimately increasing inflation. Higher interest rates help control inflation by deterring people from borrowing.
Setting interest rates
The Fed meets several times per year to review the state of the economy and set interest rates based on their discoveries and predictions. Their goal is to help the economy remain balanced. A balanced economy is a stable economy. One way they do this is with the Federal Funds Rate.
What is the Federal Funds Rate?
The Federal Funds Rate dictates the rate at which banks lend reserves to other banks. It’s a highly important interest rate because it influences the financial conditions that hold weight over the US economy. This includes employment, growth, and inflation. It also indirectly influences home loans (as well as loans on credit cards, cars, etc.).
What does the immediate future hold?
As of now, it’s expected that the Fed will raise interest rates two or three times more this year. The economy is strong, with a low unemployment rate and more people spending freely. What is good news for citizens is bad news for prices: a strong economy does mean higher inflation. The anticipated rise in interest rates will help curb price increases.
For those interested in buying a home, rising interest rates translate into higher mortgages. Locking in a rate before rates go up can save thousands.
By Michaela Phillips. Michaela is the Vice President of Mortgage Lending at Guaranteed Rate, Inc. Contact Michaela at 303.579.5517, e-mail firstname.lastname@example.org or visit michaelaphillips.com. NMLS:312874.