Investing Basics, Ch. 1: What affects interest rates


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how are interest rates determined

How Interest Rates Are Determined


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** How Are Interest Rates Determined? **

By Kimberly Amadeo, Guide

"How interest rates are determined."

Low interest rates drive economic growth. (Photo: Spencer Platt/Getty

*See More About*

· interest rates
· economic indicators
· fed funds rate
· treasury bonds
· real estate

-What Interest Rates Measure:-

The term interest rate could mean anything from the Federal Reserve's Fed
funds rate to any of the Treasury Note yields to the 30-year fixed-interest
mortgage rate. Since these rates usually move together, the term interest
rate usually means any bank lending rate.

-How Interest Rates Are Determined:-

Different types of interest rates are driven by different forces. Variable
interest rates are just what the name says -- they vary throughout the life
of the loan. Until the housing boom in the early 2000s, they varied along
with the Fed funds rate. That is the target interest rate directly
controlled by the Federal Reserve. For more, see How Exactly Does the Fed
"Cut" the Fed Funds Rate?

As the housing boom accelerated, new types of variable interest rate loans
were created. Some varied the rates according to a schedule. The first year
was 1% or 2%, then the rate jumped in the second or third year. Many people
planned to sell their home before the interest rate jumped, but some got
caught when housing prices started to fall in 2006.

Even worse was the interest-only loan. Borrowers only paid the interest,
and never reduced the principal. The worst was the negative amortization
loan. The monthly payment


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