Finance 411: How to report on interest rates

By Paddy Hirsch

Interest rates sound pretty dull, at first. But they are the seed from which all financial benefits and woes in the economy spring and, therefore, a vital part of personal finance reporting. 

An interest rate is quite simply the amount of money that someone pays to borrow a loan. And the vast majority of Americans have taken out loans of some kind or another. Household debt in America is more than $16.9 trillion. That includes our mortgage debt, auto loan debt, school loan debt and credit card debt. That’s a lot of interest being paid by Americans, every month.

Fixed and floating

There are basically two kinds of interest rates: fixed and variable. 

A fixed rate loan comes with a set interest payment that doesn’t change through the entire life of the loan. Most auto loans come with a fixed rate, as do most student loans. And 30-year mortgages are generally also fixed. You pay a set percentage of the principle, say three percent, every year until the loan matures and has to be paid back.

Credit card loans and many home equity loans have variable interest rates. Often this means that they are a fixed percentage that “floats” over a base rate. As the base rate moves up and down, so does your interest rate. For example, if the interest rate on your loan is 3 percent over a base rate, your actual payments will depend on how the base rate moves. If it’s 2 percent in January, you’re paying 5 percent. But if it rises to 3 percent in February, you’ll be paying 6 percent. 

All about that base

If a loan comes with a variable interest rate, the consumer needs to know which base rate the lender is using. And there are a number of different base rates out there, depending on the type of loan. 

If it’s a credit card, or a car loan, the base rate cited in the fine print of the loan agreement likely will be the prime rate. It’s the rate at which banks lend to their most favored customers. The interest rate on the consumer’s loan will be a certain number of percentage points above that rate and will vary as the base rate fluctuates.

If the loan is an adjustable rate mortgage, the interest rate might be based on the cost of funds index, which is a regional average of interest rates. Again, the interest rate on the loan will be a certain number of percentage points above that rate.

And some loans still use a base rate called LIBOR, the London Interbank Offered Rate, although this base rate is being phased out now. 

Eyes on the Fed

The lowest base rate of all is the federal funds rate. It’s the super-low rate at which banks lend to each other overnight. It’s the rate we talk about when we talk about the Federal Reserve setting its target for interest rates. It’s important because it is the rate on which all other interest rates are based, whether they’re fixed or floating. And that’s not just for consumer loans. It’s also for corporate loans and for bonds. That’s why there’s such a hullabaloo every time the Federal Reserve makes its announcements about where it wants interest rates to be. 

Fortunately, it’s easy for journalists to get the information we need to cover the base interest rate. The Federal Reserve Open Market Committee has a good website, including a calendar for the eight times it meets during the year. The committee issues a press release after those meetings, often accompanied by a televised statement by the chair of the Federal Reserve, stating which way the Fed wants interest rates to go, and how it plans to steer them that way.

And those calls aren’t just a big deal for households with mortgages and car loans and credit card balances. They’re a big deal for the entire economy. The Fed uses interest rates as one of its primary tools to heat up or cool down the economy. If it feels the economy needs more juice, it will push rates down, making it easier to borrow and to buy stuff. The more we buy, the more money companies have to grow and hire and buy stuff themselves. If the economy’s running too hot, a higher base rate pushes borrowing costs up. For anyone carrying debt, that means less money to spend. Households shop less, which means companies make less money. They spend less. They hire less. They cut their growth plans.

The base interest rate, then, governs the state of the entire economy, from the biggest firms to the smallest homes. That’s why covering rates is a crucial part of a financial journalist’s portfolio.

Additional Resources: 

Federal Reserve Bank of New York: Effective Federal Funds Rate

Federal Reserve Board: Daily Interest Rates

Paddy Hirsch is a Freelance Reporter for NPR. He can be reached at paddy@paddyhirsch.com and their website is www.paddyhirsch.com. Finance 411 is a bi-monthly feature, presented by RTDNA and the National Endowment for Financial Education. Interested in becoming a contributor? Email info@rtdna.org for more information.