Banks are in the business of securing money and making as much of it as they can in the process.
Many believe banks' profits are contingent on the seemingly never-ending fees they charge for their products and services, like checking accounts. These fees run the gamut from monthly maintenance fees to charges to close accounts.
These various costs are extremely annoying for consumers, but they don't carry the impactful weight people think they do. Instead, the bulk of banks' earnings come from the interest they collect on the loans they make.
Given the direct effects that interest rates have on banks' bottom lines, they guard from their customers many of the details that can shew them away. They don't want to arm their customers with the knowledge they need that could cause them to sign up with a competitor.
Banking regulations provide that banks must make certain disclosures to their customers. Unfortunately, many people don't read these statements. Those who do may not clearly understand them. This includes understanding the nuances of interest rates.
Your cash, their money
Institutions in the banking sector include commercial banks that specialize in offering retail services. Commercial banks are known for issuing loans and accepting deposits. They also offer checking and savings accounts and CDs (certificates of deposit).
Through their retail customers, banks are able to amass tremendous cash holdings. When interest rates rise, their profitability also increases because yields are impacted positively. The financial institutions that benefit the most from rate increase are those that provide services like loans.
Prime rate and federal funds rate
When you take out a loan, the interest rate you are charged is called the prime rate. The federal funds rate is the rate the Federal Reserve assesses to commercial banks on loans it provides to them.
"The prime rate is the lowest interest rate available for non-banks to borrow money – similar to the federal funds rate that the Federal Reserve uses to loan banks funds. The prime rate (also called "prime lending rate," or even "prime") is the rate at which banks loan preferred customers funds for mortgages, loans and credit cards, and is the best rate customers can obtain."
Banks tend to adjust their prime rates at the same time, according to The Street. The finance news outlet adds that the rates are usually adjusted in tandem with the Federal Funds rate.
Banks borrow from one another on a short-term basis, while they lend to customers on a long-term basis. Because long-term rates often rise faster than short-term rates, the spread between the two expands as rates go up.
Gus Faucher, the chief economist at PNC Bank, told to the Daily Herald:
The rate influences the country's financial system because interest rates on existing variable-rate loans typically rise in lockstep with the Fed. Interest rates on new fixed-rate loans may go up as well after the Fed raises its rate.
The art of negotiating
Maintaining a good relationship with your bank could put you in a position to negotiate more suitable, lower rates. In many cases, banks are willing to adjust their interest rates for customers who've established long-term relationships with them that haven't been flawed. This means few or no bounced checks, as well as no delinquencies on outstanding loans.
It could behoove you to ask your bank about lowering your rate. You may be able to lock into a fixed rate that will not change during the life of the loan, according to Lakhbir Lamba, who is an executive VP at PNC Bank. However, keep in mind that fixed-rate loan holders don't enjoy lower borrowing costs like variable-rate loan holders when rates fall.
While negotiating rates on your mortgage may be done easily, that may not be the case with credit cards. Interest rates for credit cards are typically variable because they are tied to the prime rate. When prime rate moves higher, so do credit card interest rates.
If your bank doesn't work with you to lower your rates, start shopping around. You may find other banks that already offer lower rates, especially to entice potential new customers to sign up for their accounts. Just beware of the introductory offers used to lure you into signing up for a credit card. The rate for these offers is typically between three and six months. After that, it can skyrocket.
Don't get left out
While it is true that new customers are often privy to special interest rate offers, existing customers should not fret. Your bank may not tell you, but often banks will allow existing customers to sign up for accounts that offer lower rates.
According to CBS News:
"Instead of raising interest rates on existing savings or money market accounts, banks will launch a new account with a rate higher than their existing account rates. This new account is marketed only to new customers. Sometimes when banks offer these new accounts, they will allow existing customers to open them. However, it's often up to the existing customer to find them."
One of the best ways to increase your savings is to open a savings or money market account. Inquire about opening one, but know that banks will often require money from another bank to fund it.
Also, according to CBS News, you should be aware of the CD's maturity dates and steer clear of promotional CDs that automatically renew.
Most promotional CDs will automatically renew to a similar-term standard CD with a rate that will likely be much lower than the promotional CD rate. CD customers can close a CD without a penalty during a CD's grace period which starts when the CD matures and typically extends five to 15 days after maturity.
That promotion you're offered to open a CD may be too good to ignore, but you should be cautious of the drawbacks. For example, if you make early withdrawals, the penalty can be severe. Also, there could be penalties assessed if you close it early or when it matures.