Financing costs directly affect cash flow and most funds used to finance commercial properties are adjustable rate loans. Such loans allow banks to continue to make a profit even though rates 

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overall have risen since first issued. When the Fed raises or lowers rates, which rates are they directly affecting? The Federal Reserve has the authority to raise or lower the Federal Funds Rate which will also affect the Discount Rate. When those rates are adjusted by the Fed, the Prime Rate also moves upward, but not because of any direct action by the Fed but indirectly moved. Let’s look at the three rates and understand what they are and how they’re used.

The Federal Funds Rate is the rate that banks use to lend to one another on a very short term basis, as in overnight. Banks and other depository institutions are required to keep a specific amount of cash on hand compared to credit extended their customers at the end of each day. When banks have excess, they can lend those funds to other banks that need to meet daily reserve requirements.

Banks can also borrow money directly from the Federal Reserve Bank to meet reserve requirements instead of borrowing from another depository institution. Usually when a bank goes to the “discount window” it’s because another lending institution will not lend to the bank at the Fed Funds rate and is usually about 100 basis points above the Fed Funds rate, discouraging banks from going directly to the Fed for a loan before exhausting other resources to shore up reserve requirements.

Finally, the Prime Rate, or the Wall Street Journal Prime Rate, is the result of a Journal’s survey of 30 banks. If more than three-quarters of the banks change their best rates issued to their best customers. The Prime Rate moves in step with the Federal Funds rate and when the Fed Funds rate moves, banks will adjust their Prime Rates as well.