Interest Rates 101: How Banks Set Your Rates

By Candice Choi, AP Personal Finance Writer

NEW YORK (AP) — Interest rates on credit cards and mortgages seem to move in mysterious ways.

When Standard & Poor's downgraded the country's debt rating, for example, most experts thought mortgage rates would start climbing. Yet rates slipped to record lows the following week.

Then consumers were expected to cheer when the Federal Reserve said it would keep interest rates close to zero for another two years. But if the Great Recession is any indication, that's no guarantee that credit card rates won't spike anyway.

Although the linkage isn't always clear, shifts in the broader economy do ultimately impact how much consumers pay to borrow money. It's just that making direct cause-and-effect pronouncements gets confusing because banks use a variety of benchmarks to set rates on various loans.

A mix of other factors can push up costs as well; the borrower's credit history is just one variable. Here's how recent developments could impact four common loans:


The majority of mortgages come with a fixed interest rate over the life of the loan. Rates have been hovering near record lows for the past year, which is why it's a good time to refinance or consider becoming a homeowner.

This era of low rates was expected to start tapering off when S&P downgraded the country's debt this month. That's because mortgage rates are tied to the yield on the 10-year Treasury note. The thinking was that a blemished credit rating would require the government to increase the yield on those bonds, raising its total borrowing costs.

But the lack of confidence in the global economy and a volatile stock market caused the opposite to happen. Investors have continued to seek the relative safety of Treasurys, which in turn pushed down yields.

As a result, the average rate on a 15-year mortgage, a popular refinancing option, hit an all-time low of 3.50 percent last week. The rate on a 30-year fixed mortgage fell to 4.32 percent. Given the ongoing economic uncertainty, a mortgage strategist at Credit Suisse estimates rates will continue falling toward 4 percent by the end of the year.