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Not many of us are aware of the impact a change in rates has on our daily lives, they can be confusing so we've put together a short description of the common indexes used for Adjustable Rate Mortgages to guide you through.

Prime Rate

This can be defined as the rate charged by banks to their most credit worthy customers for loans. The term on its own is generic but in the States, it primarily refers to the Wall Street Journal Prime Rate. As reported by the Federal Reserve, this is usually posted by a majority of the largest banks and is usually 3% higher than the Federal Funds rates (this is determined by the Federal Reserve), so when the Fed drops its rate, you can expect the Prime Rate (in most cases) to fall as well. Depending on economic conditions, this index can be volatile or not move for months at a time. If you've got a credit card, then keeping tabs on this rate is highly recommended as it is associated with all types of consumer debt. This figure is normally printed by the Wall street journal once a month.

Federal Funds Rate

As indicated by its name, this is set by the Federal Reserve and is the interest rate at which banks lend money to each other, usually on an overnight basis. One of the consequences of having a reserve limit is that sometimes banks, in trying to stay as close to that limit as possible may go under it and thus need to borrow some money to boost their reserves. The Fed Funds Rate is used to control the supply of available funds, thus having a bearing on inflation and other interest rates.

Federal Discount Rate

As defined by the Federal Reserve, this rate is defined as the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility-the discount window. The Federal Reserve Banks offer discount window programs to depository institutions primary credit, secondary credit and seasonal credit, each with its own interest rate. All discount window loans are fully secured. The discount rate charged for primary credit (the primary credit rate) is set above the usual level of short-term market interest rates. (Because primary credit is the Federal Reserve's main discount window program, the Federal Reserve at times uses the term 'discount rate' to mean the primary credit rate.) The discount rate on secondary rate is above the rate on primary credit. Raising the rate makes it more expensive to borrow from the Fed, which is how it controls the supply of available funds. The more money readily available, the higher the likelihood of inflation occurring.

Published on April 4, 2008