#UnderstandingInterestRates #WhereDoesTheMoneyGo #FinancialEducation #EconomicImpact
Have you ever wondered where the increased interest rates go and who benefits from them? 🤔 Let’s break it down in a simple and straightforward way to understand how this financial concept works in the real world.
Interest Rates 101
Interest rates play a crucial role in the functioning of the economy. When interest rates go up, borrowing money becomes more expensive, discouraging people from taking out loans for various purposes like buying a house, car, or starting a business. On the other hand, saving money becomes more lucrative as banks offer higher interest rates on savings accounts and other investments.
Where Does the Money Go?
1. **Banks and Lenders:** One of the primary beneficiaries of increased interest rates are banks and other financial institutions. When you take out a loan, you agree to pay back the principal amount along with the interest. The additional money paid as interest goes to the lender, which can be a bank, credit union, or any other lending institution.
2. **Investors:** Higher interest rates can attract more investors to purchase bonds and other fixed-income securities. As a result, the government and corporations can raise capital by issuing bonds at higher interest rates, ultimately benefiting from the increased inflow of funds.
3. **Savers:** Individuals who have money saved in savings accounts, certificates of deposit, or other interest-bearing accounts can receive higher returns on their investments when interest rates go up. This can help them grow their savings over time and combat inflation effectively.
Impact on Borrowers
While increased interest rates can be beneficial for savers and investors, it can have a negative impact on borrowers. People looking to take out a mortgage, car loan, or personal loan may end up paying more in interest, making these loans more costly and potentially reducing their purchasing power.
In Conclusion
Overall, the money generated from increased interest rates benefits banks, lenders, investors, and savers in different ways. Understanding how interest rates work and where the money goes can help you make informed financial decisions and navigate the complexities of the economy more effectively.
Next time you hear about interest rates going up, you’ll have a clearer picture of who stands to gain and how it can affect your financial situation. Remember, knowledge is power when it comes to managing your money wisely! 💪🏼💰
By demystifying financial concepts like interest rates, we hope to empower you to make informed decisions and take control of your financial future. If you have any more questions or need further clarification, feel free to reach out to us for personalized assistance. Happy learning! 🌟
#FinancialLiteracy #MoneyManagement #EconomicKnowledge #SmartInvesting
Whoever is lending money: savings account interest, CDs, bonds, federal Treasury notes, and so on
TLDR: The banks and financial institutions make more money, but so do people with invested savings.
Interest rates effect all loans such as mortgages, car loans, and business loans.
As interest rates go up loans become more profitable for the banks, but it becomes more difficult for the average person and businesses to borrow money. On the flip side higher interest rates is good for savings as it increases how much you make from saving and investing your money in products like bonds, savings accounts, or mutual funds.
Conversely lower interest rates means it’s easier to borrow money which can help move the economy forward, but makes savings products less attractive.
The government has mechanisms to work with the banks to increase or decrease interest rates.
For the government it’s a balancing act to help people save money for retirement and help the banking industry profit, vs making it easier to borrow money to help people buy homes and businesses to expand.
So to ELI5 – everybody who has money saved in something that gets interest is getting more.
So savings accounts that used to be almost 0% interest are now getting a few percent. So normal Joe with a savings account gets a bit.
Bonds (money lent to companies borrow for set interest) used to be 1 or 2% are now 4 or 5%. So normal people who invest put part of retirement in bonds get some.
Treasury Bonds (bonds from the government) are higher – so the government is paying more to borrow money. So conservative people who buy safe Treasury bonds are making a bit more.
Banks are paying more for the money they get (through savings accounts or federal loans) – so they are pushing up the rates on loans for houses or cars to make up for it.
And Angel lenders (people who are not banks who lend to businesses) are getting crazy high rates. Because money is hard to find so new risky businesses have to pay through the nose.
So everyone who has invested their money by lending it to anyone- either by loans, or buying bonds, or by putting in a savings account to lend to a bank – they are getting the profits.
Loans in the United States mostly originate from the government. The fed sets an interest rate, and banks show up to get the loan from the government. The bank then turns around and re-lends that loan out to a business or an individual. The bank operates as a middle man and sets their interest rates higher than the government so they can make a profit.
The business makes payments on the loan to the bank, and the bank makes payments back to the government.
At the end of that process both the government and the bank has made their money back with interest, and they can now use it to issue more loans.
The government can raise or lower interest rates to reduce the “monetary supply” which will (indirectly) induce or curb spending.
From citizens the money go to the banks. And bank pay more to the central bank, because they also have loans. That money goes to the government. Finally some interest will be paid to you by the banks for letting them keep your money. This will hopefully have a medium to long term effect in reducing inflation growth.
It might be easy to think of interest rates as the “energy” of the economy. For sure, higher rates earn more $$ for banks, but it also cost them more to get the money they lend out. It’s turtles all the way down, sort of.
Ultimately, the government, which doesn’t really care about profit because it can print money… they increased interest rates to take energy out of the economy. They may lower rates to add energy back in.
Interest is the amount the bank charges to borrowers and pays to savers.
If you have $1000 in an account paying 4% per year, after a year the bank gives you $40 as they’ve had your money and been using it.
They used it by lending it to a borrower, probably at more like 5% per year, earning them $50. The $10 difference is profit for the bank.
As rates rise, the extra money goes to the bank and to the savers, though usually the borrowing rate increases faster and higher than the saving rate.
Simple, the banks.
Why do they need to follow the feds rates?
Because the banks get their money from the feds.
Why adjust rates?
To influence your spending behaviour.
Does it work?
Yes, because you have finite money with infinite stuff to spend on.
Interest is the ‘price’ of capital. Just like any ‘price’ it is subject to supply and demand. No one is going to take a 3% loan if they can get a 2% loan. Thus, the federal reserve’s interest rate sets the BASE interest for ANY loan any other institution is going to offer.
tl;dr
It goes into the pockets of the people who loaned the capital.
A loan is a service. Like any other service, a loan costs money. Interest is the price of getting a loan.
When interest rates change, just think of that as the price changing for a loan. The money goes to the bank as profit.
When prices for doritos go up, prices for loans also tend go up. The mechanisms for those price increases are different, but you don’t really need to know all the details for a basic understanding.
Prices for eggs go up, so do prices for loans. High interest rates. Prices for eggs go down, so do prices for loans. Low interest rates. That’s the economy.
Banks borrow from each other on a daily basis, as well as borrow money from the Federal Reserve bank. Why do they do this? Because they have something called a ‘reserve requirement’, that they need to have at least a specific percentage of all their holdings locked up. So to maintain that balance they are constantly shifting money too and from the fed and to and from each other.
Say a bank has a million bucks today deposited by customers. The reserve requirement might say that they have to hold 100,000 on hand at all times. But they want to loan that money out, not hold it, so they buy ‘notes’ from the Federal Reserve that covers the reserve requirement for the day and instead lend out the 80,000 of the 100,000 they have to have.The next day they pay that note back for whatever the note costs plus a small fee. They then buy the next days note from the Fed to maintain that reserve requirement. Or they buy it from one another. There is a lot of horse trading between banks and between the fed on a daily basis.
When ‘interest rates’ go up, that means that the interest rates the banks pay the Federal Reserve goes up. Because that’s the lowest interest loan they can have, they base the cost of loans they make to customers (You, me, companies) based on that rate + a percentage more that is their profit. If the Fed Rate is 1.25 percent, the rate they set to you for a car loan might be 4.25 percent. If the fed raises interest rates to 1.5 percent, the next day banks might make that car loan rate 4.5 percent.
Simply the extra money goes to the lenders. When you buy a house with a mortgage or car on finance or spend on your credit card someone is lending you money, and the interest is the extra money you pay them for lending you the money. At the end of the line there is a private investor or investment company who buys the debt and gets the money.
When you open a savings account or buy a bond you get paid interest because you are lending money to the bank or bond issuer.
Rich people. Don’t listen to these people.
This is boom-bust intimately connected to the money supply. Boom, the owners of capital have free money to make more money. Bust, the owners of capital make more from what remains.
If there was real risk, it wouldn’t be so bad. But QE has proven there’s no real risk.
You’re a slave. The only people who can lose money like that have IQs in the low double-digits.
So much for meritocracy or entrepreneurial spirit.
Into savings accounts of people’s banks previously with very low interest rates the money had to come from somewhere so it came from savings accounts.
Like I’m getting 5% in my savings account now previously that 5% went to reducing someone’s mortgage yeah fuck them
Well when you are getting a personal loan, the extra money is going to the bank that lent it to you. It’s as simple as that. But keep in mind banks also pay interest for the money they hold, and those rates are also higher.
So the next question is: how does the government get everyone to raise the interest rates they charge? The answer is bonds. Basically, if you want to invest your money in a way that won’t make a lot but is as safe an investment as possible, you buy government bonds. Basically you buy a bond and at a predetermined time down the road, you can cash the that bond in for a small profit. When the government wants to slow down the rate people are lending and spending money,
they increase the payouts for those bonds. When they raise the yield on these bonds, it makes them more attractive to investors. When interest rates were zero, banks wouldn’t bother with them, so they had to offer really attractive interest rates on personal loans to make a profit. You could’ve for example, gotten a 2% rate on a mortgage. But if the federal interest rate is 4%, the bank has absolutely no reason to give anyone a 2% loan. They might as well just take that money and buy bonds at 4% with zero risk. So the only time they’ll offer a personal loan is if they can make significantly more than they would with a bond, which is why interest rates have been between 6-8% in the last year.
Interest rates aren’t a thing that goes somewhere. They’re a measurement. Specifically, to answer the question, “how much money in the future is worth money now?” Or sometimes, “how much do I have to charge to make it worth loaning money to someone who might not pay it back?”
So, let’s look at someone that definitely will pay it back. If you get a 5% interest rate, that means (oversimplified) that you if you borrow $100, and you pay it back in a year, you pay $105. That extra $5 is for a couple things. First, inflation (which is a discussion on its own). Second, when you get that money, the lender doesn’t have it until you pay it back. They can’t use it for groceries or power bills or rent. So you pay for that too.
Now let’s look at people that might not pay it back. Let’s say 10 out of 100 people that borrow money don’t pay it back. The bank gives out $100 x 100, or $10,000, and needs to end with $10,500 (the same 5% profit). So the 90 people that pay have to pay $116 67 each to make that happen, or 16.67%.
And banks and other lenders do a lot of research and spend a lot of money to figure out what number to set to help them figure out how likely you are to pay it back. Because if they can figure out better than credit scores do, they can make a lot of money.
Banks take your money and keep it safe for you. They loan it to a business or home buyer for 4% interest rate. They keep 3% of it for themselves, and give you 1% interest on your money as a way to encourage you to save it with them.
Interest rates are low all around (for you as a saver, and for people taking out loans). This encourages more people to take more loans and save less.
Now interests rates are raised. Everything is still the same, except banks give out loans at 8%, keep 5% for themselves, and give you 3% for your saving. This encourages people to save more, and few people are willing to take out loans.
Interest rates are “normal” now. Its prices that are insane. You think it’s bad to make 5% on your deposits? Is that not good for savers building weath through savings? When they charge more they pay more. It’s how banking is supposed to work.
The interest goes to the lender, or more accurately the dif between rate they charge and rate they pay. About 2% ish. Regardless of rates, that num should stay the same.
A laypersons perspective.