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
The mortgage rates are going up effectively because they’re being driven up by competition. The Fed interest rate is basically the “most free” money- its super short term and almost impossible to default. So every other interest rate goes up in return- because why would you lend money to someone for a house at the same rate when there’s some risk vs a bank to bank transfer that’s basically guaranteed.
The money disappears because people can borrow less. If you need to pay 1 percent interest on your million dollar home, it costs 10k to service. That’s the same as it costs to service a 2 percent interest rate on a 500k home, so taking principal put of the equation you can’t borrow nearly as much. In turn, the people selling those things start bidding down their prices because now the people buying their stuff can’t afford it.
This guy has the best explanation I’ve seen: [Saifedean at Bitcoin 2022](https://youtu.be/0YolMBHCRis)
The way banks make money is they borrow money at one rate and then lend it out at some higher rate. The rate at which banks borrow money is called the bank’s “cost of funds”. If the cost of funds goes up and the bank doesn’t adjust the rate at which they lend money, the bank’s revenue will go down. This is why banks generally increase interest rates in step with the Fed’s moves.
The Fed does not directly set the rate at which banks borrow money, but they do influence rates through several mechanisms which I won’t explain here. The rate is a “target” rate, but in general the rate is influential enough to raise or lower banks’ cost of funds. The Fed does this to roughly influence the amount of lending in the market. If there is “too much” lending then prices start to go up (aka inflation) as there’s more “cheap” money in the economy. The Fed is on general always trying to strike a balance between a growing economy and controlling inflation.
Haven’t seen this in the other comments so far so just wanted to add that (in the US) most people’s mortgage interest rates do not change from whatever it was when they got the mortgage. About 90% of US mortgages are FIXED RATE loans, meaning that your rate remains the same for the duration of the loan and is not impacted by the Fed’s key interest rate or the current rate the bank is charging on new loans.
The other ~10% are ADJUSTABLE RATE mortgages and, as others have explained, the increased payments resulting from a rate increase would go to whoever holds the mortgage, not the Federal Reserve or the US Treasury.
So the term “extra money” is a little loaded here. In simple terms, Interest goes up because of inflation. That means that everything in the economy is becoming more expensive, or to look at it another way, the dollar is worth less or buys less. Because Inflation affects everything (though not alway evenly), it means that interest rates aren’t “extra money” as such.
Interest rate hikes are a response to inflation. Inflation means your money today is worth less than it was last year. As far as banks are concerned, they aren’t getting more money. Putting it another way, if a gallon of gas was $2.00 a gallon five years ago and today it is $5.00 a gallon, and you borrowed $2 from me five years ago and are going to pay it back today, if you paid me $2 I’d be pissed because I lost purchasing power. If you paid me $3 interest on top of the $2, I’m not really making money, you are just paying more to adjust for inflation.
Lot of complicated answers here for a simple question…
tl;dr: The interest is collected by the Fed from banks loaning out mortgages (and by extension, the homeowners). Most of the interest is written off and thus removed from the economy to help counteract inflation.
===
The Federal Benchmark Interest Rates are the interest rates used when the US Federal Reserve loans money to banks, usually to back mortgages. The banks are who pay this interest. (Banks can and do pass that and more to the customer but that doesn’t affect this question.)
So the US Federal Reserve loans out all this money and collects a set percentage of it as interest. Some of that interest is used to supplement additional loans and some is used to pay for the operating expenses of the US Federal Reserve. The remaining 95% (made up number) is simply written off.
The Federal Benchmark Interest Rates don’t exist to make money for the US Federal Reserve. They exist to remove money from the economy as a method to limit or reduce inflation.
Economists will tell you that having a moderate amount of inflation is a good thing and they have a pretty solid argument. If you have reverse inflation (or deflation), the value of money held in saving increases over time which disincentivizes spending (“Why spend it now if it’ll be worth more tomorrow.”) Free-wheeling inflation causes the price and goods to outstrip the increase of pay. In both cases, you end up with fewer people spending money which is bad for the economy.
The Federal Reserve exists primarily as a means to control inflation. Congress appropriates a shit ton of money for some reason or another (stimulus checks, for example) which drastically increases inflation. So the Federal Reserve increases the benchmark interest rates to remove this money to slow inflation. They just didn’t do it quick enough in this case and now a McDonald’s meal for 2 can exceed $20.
The Federal Fund Rate that the Fed targets is the rate that banks lend to each other. So the answer is, the banks lending the money to other banks.
Since the loans between banks are basically perfectly guaranteed to be paid back, this is risk-free and generally lowest possible market rate for any loan, since why would a bank ever make a riskier loan at a interest rate lower than a risk-free loan?
Because of this when ever the Fed increases the Federal Funds Rate, all other loan rates tend to go up so that they remain competitive. If those loans didn’t go up, banks would make fewer of them in favor of less risky loans that are now paying higher interest rates.
Latest Answers