Updated October 8, 2024.

Interest rates are in the news.  Last month, the Federal Reserve Bank lowered the Federal Funds Rate by one-half point, which was more aggressive than the predicted quarter point.  The rate is now at 4.75 percent.

In even better news, the Fed has signaled that future rate reductions are likely in a multi-year cycle.  Some respected economists are predicting a rate of 2.9 by the end of 2026.

So what does this mean for individuals and small businesses?  Different and confusing interest rate benchmarks sometimes create bewilderment.

In an effort to add a bit of clarity, the three benchmark interest rates we’ll discuss in this article are (1) the Federal Funds Rate, (2) the average lending rate for bank customers, and (3) the prime rate.

1.  Federal Funds Rate

The Federal Funds Rate, which is mentioned above, is the interest rate at which banks lend money to each other overnight in order to meet the reserve (liquidity) requirements set by the Federal Reserve.  Banks with a surplus of funds can make a few bucks by lending money overnight to other banks that need to boost short-term liquidity to meet federally set minimums.

The Federal Funds Rate is set by, and is a tool used by, the Federal Reserve to implement monetary policy and influence the overall level of interest rates in the economy.

By adjusting the Federal Funds Rate, the Federal Reserve can affect borrowing costs for consumers and businesses, which in turn can influence spending, investment, and overall  economic activity.

Lowering the federal funds rate encourages borrowing and spending, stimulating economic growth, while raising the rate can help combat inflationary pressures by reducing borrowing and spending.

The Federal Funds Rate is, without question, the most important benchmark rate upon which all other interest rates hinge.  Your car loan, your home mortgage, your small business working capital loan, and your return on Certificates of Deposit are all directly related to the Federal Funds Rate.

As this is being written in October 2024, after the half point reduction in September, the Federal Funds rate is 4.75, down from 5.25 percent.

2.  Average Lending Rate

The average lending rate is not an official benchmark, and is used in this article as an attempt to explain what rate you could expect if you walk into your bank to apply for a loan.

At the very least, most banks try to maintain a three percentage point spread above the Federal Funds Rate.  So currently, you could expect to pay 7.75 percent interest, or most likely something a bit north of that.

3.  Prime Rate

The prime rate is the interest rate that commercial banks charge their most creditworthy customers, typically wealthy individuals, large corporations or governmental entities.  This benchmark is sometimes quoted as the “Wall Street Journal Prime.”

In Conclusion

The Federal Reserve System has learned quite a lot in recent decades about successfully managing the United States economy, particularly in the aftermath of the Great Recession of 2008 and 2009.  The Fed’s management skills are much improved today.  Their corrections are timely and more expertly applied.

Interest rates are a key tool in the Fed’s toolbox, which is why we’ve heard so much lately about rates in the current economy.

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William Bruce’s undergraduate degree is in economics and he has served as a bank director, which has given him an understanding of how the Federal Reserve System works.  He is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  William currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   With offices in Fairhope, Alabama and Baton Rouge, Louisiana, he may be reached at (251) 990-5934 (Fairhope), 225-465-5799 (Baton Rouge) or by email at Will@WilliamBruce.org.