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Important Interest Rates That Impact You

December 29, 2010 by Eric Rosenberg

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If you are getting a loan, or have a credit card, or have money in a bank account, or partake in any number of other financial activities, you have seen the term interest rate thrown around.  Interest rates are one of the most important financial concepts, and understanding where they come from is important to your financial future.

Risk Free Rate

Investors generally consider government debt to be “risk free.”  Greece, Spain, and Ireland are recent examples of that not being the case all the time, but countries like the United States and Germany are considered financially stable.  As such, a loan to that government is risk free.

In the United States, the risk free rate is pegged to Treasury Bills, often called T-Bills.  You can see the T-Bill yield curve at the Treasury website.  In Europe, German government bonds are most commonly used as the debt free rate.

Interbank Rates

At the end of the day, some banks need funds to fulfill their obligations.  Other banks have extra cash.  The Federal Reserve has developed a system for overnight, interbank loans.  Those loans are made at the Fed Funds rate.  When you hear that the Federal Reserve board made a change to interest rates, this is the rate they are referring to.

This rate is important to consumers because it is a driver of the interest rates you pay on a loan.  You always pay more than the interbank rate.  If the Fed raises or lowers the interbank rate, your rate will change as well.

In much of the world, LIBOR is used as the interbank rate.  LIBOR is the London Interbank Offer Rate.  It is used internationally as a benchmark rate for many floating rate investments.

Prime Rate

Prime is the interest rate a bank gives to its best customers when it makes a loan.  Most major banks choose their own prime rate, though some regional banks look to larger banks for their prime rate.

Floating rate business loans are often quoted as “Prime plus ___,” where the ___ is an interest rate added on for risk.  A small business might get a loan at prime plus 5% where a large business might get a loan at prime plus 1%.  That is because the small business has a higher risk of default than the large business.

Your Interest Rate

At the end of the day, this is the rate that really matters to you.  Your investments and loans all come with an interest rate.  That rate compounds over time.  This is a very powerful concept.  As Albert Einstein once said, “compound interest is the most powerful force in the Universe.”

Questions?  Hit me in the comments.

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Filed Under: Debt Management, Investing

About Eric Rosenberg

Eric is the founder and editor of Personal Profitability. He left his corporate finance job in 2016 to take his online side hustle full-time and now earns a six-figure online income.

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Comments

  1. MoneyCone says

    December 29, 2010 at 11:23 am

    Awesome post! Great job explaining various rates! Having a good credit ensures you get a good rate, now that I'm shopping for a home, I'm experiencing first hand how this helps!
    My recent post Unconventional Income From Uncommon Stocks – Royalty Trusts

    • Eric - Narrow Bridge says

      December 29, 2010 at 1:24 pm

      Good luck house hunting. I used to write mortgage loans for a bank, so let me know if you have any questions.
      My recent post Important Interest Rates That Impact You

  2. krantcents says

    December 30, 2010 at 5:43 pm

    The interest we pay is indicative how responsible we are with money. The interest we earn is indicative of the risk we are willing to take. Thanks for the information.
    My recent post What is your New Year’s Resolution

    • Eric - Narrow Bridge says

      December 31, 2010 at 9:08 am

      Glad you like the post.

  3. debtfreedivas says

    January 8, 2011 at 6:53 am

    So do you think interest rates will see any significant increase this year? We are considering a refinance to move to a 15 year mortgage. Thoughts?

    • Eric - Narrow Bridge says

      January 8, 2011 at 11:25 am

      I think they are going to go up a little bit, but nothing too dramatic in 2011. As the economy gets going again, rates will slowly increase as well.

  4. Jeremy says

    January 17, 2011 at 12:51 pm

    Hi Eric,

    great post and information. I can't thank you enough for this great resource of a site you offer and your willingness to share your knowledge with everyone. I've used plenty of advice you've given over the past year since I've found your site and my finances have done a complete 180! I'm now on top of everything with Mint, my cc's are less than $500 total and my credit report is finally cleared up. 2 yrs ago my score was 515… as of today I just applied for a loan to pay off some outstanding debts and I received my score of 721!!

    thanks for your advice, knowledge, help, time, effort, etc..!!!!

    • Eric - Narrow Bridge says

      January 17, 2011 at 4:12 pm

      Great job on the turnaround. Keep it up and come back often. If you ever have specific questions, let me know through the comment form.
      My recent post Guest Post- To Coupon or Not To Coupon

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