What the Federal Funds Rate Means for the Average American Citizen

With the recent announcement by the Federal Reserve that they are lowering interest rates, a lot of information has arisen as to what effect will the lowering have on the economy. On a more personal level, people are asking how it is going to affect them, not just the country as a whole. Unfortunately, too many people don't quite understand how the economy runs and how the Federal Reserve's Interest Rate affects them. In this article, we are going to try to answer some of the basic questions regarding the Federal Funds Rate and how it affects you personally.

First off, what is the Federal Funds Rate? Simply put, it is the interest rate that banks charge each other for loans overnight. Of course, the question arises as to why banks need to borrow money from each other. The reason for this is that sometimes banks run low on their cash reserves. For every dollar that someone has deposited in a bank account, that bank must have at least 10% of that amount in cash on hand. The bank is free to use the other 90% to loan out to other people. That is how banks make money; they give you maybe 4-5% on a savings account, and then charge people 10-12% on a car loan. Basically, by using your money, they are making a pretty good profit. However, sometimes they are short of that 10%, so they need to borrow money from another bank. The Federal Funds Rate was set up so there would be a standard as to what banks could charge each other during that time.

So, what does that mean for you as a consumer? Well, the Federal Funds Rate essentially determines what percentage you are going to be charged when you use things such as Credit Cards. The Federal Funds Rate affects what is known as the 'Prime Rate.' The Prime Rate, according to Moneycafe.com, is the rate at which banks charge their best customers. While this rate is always higher than the Federal Funds rate, they are related because when the reserve lowers the money that it charges banks, they can in turn lower the Prime rate and still make money.