Q: I'm looking for a mortgage, and I'm surprised to find the numbers are all over the map. I see from your website there is also quite a difference between rates on different savings accounts. My question is this: Since the fed funds rate and the prime loan rate are set by the Fed, why is there any difference in the rates banks charge to consumers?
A: Interesting point -- after all, the prime rate has been at 3.25 percent for more than five years now. Current mortgage rates (30-year fixed) are 4.33 percent, and during the time the prime rate has held steady, those mortgage rates have ranged between a low of 3.35 percent and a high of 5.42 percent. So what's going on?
Perhaps the best way to think of this is as a difference between wholesale and retail prices. The prime rate and federal funds rate represent institutional sources of funds, so they are akin to wholesale prices. However, there are a number of factors besides wholesale cost that goes into determining retail prices. Here are a number of factors that can impact mortgage rates and rates on savings accounts:
- Your credit rating. The weaker your rating, the more you can expect to pay.
- The term of your loan. Different mortgages have different lengths, and that affects the interest. Generally speaking, longer loans have higher rates because there is more risk involved.
- The size of your savings account. Since bigger accounts are normally more cost-effective for banks, they will often pay a premium for larger accounts, in the form of higher interest on deposits. However, since banks are somewhat awash in deposits these days, there is currently no premium on large savings accounts, according to national averages from the FDIC. However, there are higher rates on average for jumbo money market accounts and CDs (those in excess of $100,000).
- The bank's asset/liability ratio. The ratio between deposits and loans outstanding is a delicate balancing act for banks. Tipping too far on the side of deposits dilutes the bank's profit margin; too far the other way can be overly risky. What a bank pays on deposits and charges on loans may therefore depend on which it is trying to attract more.
- The health of the bank's loan portfolio. The more banks fear getting burned by defaults, the more they are likely to charge on loans.
- The bank's cost structure. Online savings accounts generally pay higher rates because they have a lower cost structure.
The differences in mortgage rates and savings account rates that result from these factors may make the banking market more confusing, but they also create opportunities for consumers who are willing to do their homework.
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