What do mortgage interest rates really mean?

To cool rising inflation, which is the general increase of prices for goods and services, the Fed has decided to raise interest rates.  Interest is basically the cost of borrowing money.  The higher cost of money is the same as more valuable money, which is the opposite of inflated money.

Just a few short months ago, a borrower could get a 2.8% interest rate on a fixed-rate 30-year mortgage.  If you could afford to put 20% down on a $200,000 home, you would pay close to $1,000 a month (including taxes and mortgage insurance).  Most people buy homes for which they can afford the monthly payment.  Today, at a 6.2% interest rate, that same loan payment of about $1,000 a month will cover only a $140,000 home.  That's a drop in purchasing power of some $60,000.

The same impact of rising interest rates affects car loans, student loans, furniture loans, and every other type of financing.  Commercial businesses need loans to grow.  As they struggle with their reduced purchasing power, they must do less (and risk going out of business), borrow more (and get less and owe more), or raise their prices (potentially selling less).  Usually, it is a combination of all three.  This leads to everything from reduced availability of goods and services to reduced hiring and wages and, of course, layoffs and unemployment.

The big secret is that this purchasing power didn't just go away.  It was shifted to — and used by — the government long before consumer interest rates went up.

The federal government caused the first stage of reducing our purchasing power by adding more money to the economy.  Increasing the supply of money causes a general increase in prices as the market attempts to spread the additional dollars across the value of all goods and services.

Here is a very simplified example.  If the total economy had $1,000 in it, and there were a total of 10 goods and services available, each good and service would be valued at $100.  If $100 more is added to the total supply of money, now $1,100, there would be someone out there with that extra money able to pay more for the goods and services.  The providers of goods and services eventually recognize this and raise the prices.  This occurs throughout the economy until the value of the 10 goods and services eventually equalizes again at $110 each.

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This is often stated as "more money chasing fewer products and services."  When it happens to the economy in general, we have inflation.

But as I said above, our purchasing power didn't just go away when the government increased the interest rates.  It began with the additional money added into the economy.  It takes time for the market to realize that more money is available and to respond to it.  The government uses the newly created money to pay its own costs while it still has the previous level of purchasing power and before the purchasing power is reduced when the market catches on.

This means inflation is a form of taxation that takes some of your purchasing power and passes it to the government.  This is bad enough, but when too much money is added to the economy, inflation begins rising at devastating rates.  If there is one thing the Fed is good at, it's adding more money to the global economy.  Eighty percent of all U.S. dollars currently in existence have been printed in just the last two years.

To counter rapidly increasing inflation, the Fed increases interest rates to slow borrowing money and reduce how much money is available in the economy once again.

The Fed will likely continue rate increases for the next year or so.  We could see mortgage rates as high as 10–12%.  Imagine the hit on your purchasing power then.  I'll let you do the math.  There are certainly other things that can be done to counter inflation, but none of them, short of reducing the money supply, is very good.  By reducing the money supply, the value of each dollar increases.  Unfortunately, most people cannot take advantage of the higher savings interest rate because their purchasing power has dropped, and they cannot afford to both feed their families and increase their savings.

This ludicrous cycle of monetary policy must stop.  The government must work within a reasonably balanced budget while focusing its spending on only the very few things government can actually provide.  Until then, the Fed's printing press runs 24/7 and eats away at your home-buying power — first via inflation and then with higher interest rates.

Therefore, even though you planned on a $200,000 house at about $1,000 per month, you ended up paying that monthly $1,000 to get only a $140,000 house.  Your $60,000 of purchasing power went to the government when it used the newly created money to buy things that it could not otherwise afford.

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