Especially regarding mortgage rates- folks are paying huge increases in monthly payments.
I’m assuming “to the government” but does it just get held somewhere?
In: 67
It goes to the banks that issued mortgages. Fed’s rate hike is the hike in the rates banks pay the government in the future to borrow money. What banks charge for mortgages is up to them.
The central bank interest rate sets the amount of interest that people who owe the central bank money pay the central bank. So this money goes from central bank borrowers (usually commercial banks) to the central bank. In some countries the central bank is part of the government but in most countries it is an independent entity.
Commercial banks however will mostly then copy the central bank interest rate. So that means money will go from their borrowers (mostly people with mortgages) to those private commercial banks.
Why would you assume it’s going to the government? The government doesn’t issue mortgages, for the most part.
Okay let’s get some groundwork down first.
So the Federal Reserve is not part of the Government. It’s more like a company that has been given an exclusive contract by the Government and is owned by the banks and the Government together. Part of that contract is that the Fed is led by Presidental Appointees, and they report to Congress every so often. But they are their own organization.
One of the powers they have is the ability to set rates that banks can loan money to one another. Banks have to do this every day due to legal requirements to have their books balanced, so they offer and seek overnight loans to one another.
So how does controlling interest rates between banks giving loans overnight result in more expensive mortgages? Well no loan is in a vacuum because money loaned out in one place is money that can’t be loaned out somewhere else. So as one interest rate increases, all interest rates increase in response.
So no money directly goes to the Government or the Fed when rates go up. The rates do result in assets the Fed holds making more money though, but that is not on the same scale as what the general population pays in interest increases.
You know in the movie 300 when king leonidis went to see the old pervs, gave them money and told them his lands are his.. they stole the money and slobberd on the hoe, that’s them. That’s where the money goes.
So the interest rate they raised is what they charge Banks for loans.
This is the key part. Banks take out loans so that they can loan out money to businesses and consumers.
The interest rates a bank pay on the loan they take out is different from what they charge people who get a loan from them.
They are tied together insofar as the bank still wants to make money, so they charge their customers a higher interest rate than they are paying on their loans.
But this really isn’t generating more money in interest payments, unless you happen to already have a loan that had a variable interest rate. But since commercial banks are now charging a higher interest rate, less business and people will be taking out new loans, which is the intended effect of raising the rates, to show down spending.
Most homeowners with a mortgage likely don’t have a variable rate mortgage, so their payments won’t change. Anyone with a variable rate mortgage will be paying more, but that’s the chance you take when taking out that kind of mortgage loan. That extra money you pay goes to the bank like normal. That’s part of the Banks income stream. Some of it may possibly go towards paying off any new loans the bank takes. But more likely it won’t because the bank won’t take out new loans until they loan out more money, at which point they will be charging consumers a higher rate because they are paying a higher rate on their loan.
The answer is to banks with extra cash.
In order to stop banks from lending out a million dollars for every dollar in deposits they have, they set a hard limit of 10x assets. If your bank has 100 dollars in all savings, checking, CD, etc accounts and makes a loan for 1001 dollars they will be shut down. The Fed further controls inflation by paying the banks interest on any amount UNDER the 10x limit that’s the Fed interest rate. It’s the rate the Fed will pay a bank to NOT make loans.
When you go to a bank to get a mortgage, the bank only has so much money they can lend. They must choose between lend a dollar to you, with a risk of not getting it back, or keep the dollar and get an interest payment on it from the Fed. That’s why mortgages and other bank loans are at the Fed interest rate PLUS some amount based on how risky the loan is.
Raising the Fed rate means banks become less likely to issue loans because they have to be pickier about what they fund. The small business selling bunt cakes on the corner can only reasonably generate enough profit to pay a 2% interest loan, when the Fed rate was 0% it made sense for the bank to make that loan. When the Fed rate goes above 2%, the bank won’t make that loan because they’d get more interest payments with less risk from the Fed instead.
So you’re thinking about it backwards. The Fed interest rate is the amount of interest the Fed is willing to pay, not what they charge on loans they issue.
Edit: Teeeechnically what I described is the interest rate on reserve balances (IORB) which is what the Fed interest rate is tied to and what the Fed can directly control. The actual Fed interest rate is the target rate the Fed wants (but can’t require) private banks to charge each other. They use the IORB, which they do control, to get the banks to hit the target rate. When the Fed raises rates, they’re simply issuing a new target they want the private banks to hit, raising the IORB is how they actually make it happen.
The money goes to the federal reserve and is destroyed or locked in a vault. The goal is to reduce the amount of money in circulation so people and businesses stop making stupid purchases
So many good answers here.
I’ll add one thing.
Right now, banks are flush with cash and were lending it out very liberally. The FED would like to slow that down to stop inflation and make the economy slow down.
I tell my students the economy is like a car, and the car is overheating right now.
So when the FED “raises interest rates” one thing they are doing is paying private banks (like PNC or Chase) to keep money at the FED instead of lending it out. This is called “Interest On Reserve Balances.”
Now banks have to decided if they want to loan money to you at 5% which is a little risky (just a little, I’m sure) or put it in the FED for 1%, which is super safe.
This is all a bit new for the US.
[Here is a little graph](https://fred.stlouisfed.org/series/IORB)
To lenders.
Banks borrow money from each other and from the Federal Reserve all the time. If the Federal Reserve makes it more expensive to borrow from them, then that’s extra demand that goes onto the rest of the lending market, which raises interest rates everywhere.
Now specifically regarding mortgage rates, how those work are that investors will be willing to lend at a certain rate depending on alternative investments. Since these investors now have the option to lend directly to banks at a higher rate, they need an even higher interest rate from homebuyers to consider investing in a mortgage instead.
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