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The interest rates paid on savings accounts are not just arbitrary numbers set at will by your bank. Money deposited into savings accounts is used to fund the loans issued by your bank. This includes mortgage loans, personal loans, equity loans, etc. Your bank charges interest on these loans¾in order to make a profit. The core basis for the interest rates are rates set by the Federal Reserve based on consumer confidence and borrowing activity. Your bank adds interest on top of this federal funds rate (also referred to as prime rate) in order to develop the rate it needs to make a profit.
The bank then decides how much of this rate to pay out to savings account clients and CD purchasers. Banks pay out just enough to allow their customers a return while keeping profitable. It is important to understand this because savings account rates are not fixed. Your rate could change from month to month¾and factors¾such as those mentioned above¾determine how much it changes.
|Jennifer Mathes, Ph.D.|