Understanding How Interest Rates Change Over Time

Very few concepts in finance are as misunderstood as the relationship between interest rates set by the Federal Reserve and the interest rates seen by consumers. Many people I speak to are confused as to why mortgage rates have increased over the past several months during a period where it is all over the news that the Federal Reserve has been lowering interest rates. You’ve probably noticed this if you’ve considered getting a mortgage or loan in the past year.

In recent months, the Fed has opted against lowering interest rates further, but it has not raised interest rates since July of 2023, when interest rates peaked for this post-COVID era cycle at just over 5%. So, how can mortgage rates, credit card rates, and interest rates offered by banks on savings accounts and CDs increase now? For starters, we must understand that the only thing the Federal Reserve dictates is the overnight federal funds rate. Great, what the heck is that? Simply put, that is what banks pay to borrow money from one another (read more about that here). 

Banks that borrow from one another get the best interest rates possible, and from there, other lending rates are determined, such as mortgage rates, credit card rates, bank rates, etc. Because the Federal Reserve only dictates the rates that banks charge each other, other interest rates are established based on the free market. These free market rates are impacted by numerous economic variables such as perceived risk in the credit markets, inflation expectations for the future, and especially investor expectations on the direction of the Federal Reserve's future interest rate changes. Eight months out of the year, the Federal Reserve meets to discuss whether or not it needs to adjust interest rates to influence the direction of the economy. Their mandate is to promote maximum employment and stabilize prices.

In summary, Fed Funds rates can be whatever the Federal Reserve sets them at, but if the free market expects these rates to go up or down over the next several months, that will have a big impact on what borrowing and savings rates are going to be. As with most things in America, the free market plays a large role in the interest rates you see as a consumer.