By John W. Schoen Senior Producer
msnbc.com
COMMENTARY

With adjustable mortgages and credit card rates rising, Henry in Maryland is wondering where the extra money on his monthly payments is going. Just who profits when interest rates rise?  In Indiana, Nick is feeling a little put out because a collection agency is still bothering him about a 7-year-old debt. Isn't there some law against this?

Who profits from the additional money I pay when the interest rate goes up? If it’s the bank or credit union, it seems that all they have to do is sit around and pray that the Fed will raise rates.
-- Henry S., Odenton, Md.

There’s certainly plenty of reason to pray for the Fed, but sitting around waiting for rate changes is not a great way for a banker to make money.

Despite the generous press coverage lavished on the Fed’s interest rate pronouncements, a lot of other, more significant forces weigh on bankers and other lenders when they try to figure out how to make money. While the Fed generally gets the most attention for the very short-term rates it controls, the central bank’s influence over the cost of borrowing is often overstated.

That’s because there are many different types of borrowing, and the rates that apply to most of them have nothing to do with the short-term IOUs handled by Mr. Bernanke and his merry bank of rate-setters. Those folks focus on just two rates: the “discount rate” charged to banks when they borrow directly from the central bank, and the “federal funds” rate that banks charge each other for very short-term (overnight) loans. (Banks borrow overnight to maintain minimum reserves required by the Fed: if one bank find it’s lent too much by the close of business on any given day, it has to borrow from another one for a few hours to replenish their reserves.)

Longer term rates — whether for mortages, Treasury bonds or “commercial paper” sold by companies raising money directly in the global capital markets — march to an entirely different drummer. Whenever you get a mortgage or a new credit card — or when a company or government sells bonds to raise money — the market votes on how much that loan is going to cost. The Fed has little direct incluence over those longer-term rates, which are determined of millions of individual decisions by borrowers and lenders that make up the supply and demand for money.

In the simplest terms, long-term interest rates are determined by how many borrowers, around the globe at any given moment, want loans and how many lenders are willing to make them. If the Fed wants to gets into this act, its best bet is try to pump money into the system or draw back out, which it does by buying or selling Treasuries. (It can also easer or tighten the reserves banks are required to maintain.)  But with long-term rates, the global credit markets almost always call the shots.

It’s that difference between long and short rates that makes the world go around for lenders. Banks traditionally make money by borrowing short-term money — from depositors (you and me), from other banks or from the Fed — and then lending it out at a higher rate to customers who borrow for the long haul. So their profit comes from the (usually) higher rates they charge borrowers compared to the bank’s lower cost of money.

That gap between short and long rates is stretching and shrinking all the time. You may have heard it referred to as the “yield curve” — which is often measured by the difference between the market rate on a 10-year Treasury bond and a 3-month T-bill. When that gap is big, the curve said to be is “steep;” when it’s small or non-existent the curve is “flat.” Occasionally, long rates fall lower than short rates; the yield curve is then said to be “inverted.” (At this point Wall Street usually freaks out because this often, but not always, means a recession is coming.)

Right now, the federal funds rate (the bank’s cost of money) is at 5.25 percent and the prime rate (one of main benchmarks for pricing a longer-term loan) is at 8.25 percent. Bankers refer to the difference between their cost of money and the rate they charge — the bank’s profit — as the “net interest margin.”  It’s not unlike the mark-up Wal-mart gets for buying running shoes wholesale from a manufacturer in China and selling them at a higher retail price to fashion-conscious high school kids who don’t care what shoes cost to make .

In fact, rising rates can hurt bank interest margins — and profits. One reason is that, as the “cost” of money goes up, a fixed-rate, long-term loan locked in when rates were lower is now less profitable. So if Fed-mandated short rates move up faster than market-driven long rates, interest margins get squeezed (which is what has happened to many banks this year.)

But there’s a flip side to the rising interest rate ledger: Most borrowers are also lenders, including you and me. Some of the extra money you pay on your credit card when rates go higher comes back to you in the form of higher returns on savings (if you keep them in an interest-bearing account like a savings account or CD.)

Here again, there are winners and losers. These days, many savers avoid relatively low passbook savings accounts in favor of money market funds that invest in longer-term loans to get a better return. As rates rise, competition for all this depositor money can also raise a bank’s costs, which can further squeeze their net interest margin.

So whether rates go higher or lower, there are winners and losers on both sides of the loan. A lot depends on the direction rates are taking — and the differences between long and short rates. And for now, the Fed seems content to leave rates where they are.

I am confused by the laws concerning un-paid debt. In college I got into some credit trouble and never paid the bills. It has been over 7 years but it is still on my credit report. I am still getting threatening letters from collection agencies. Other than paying full amounts on these very old bills are there ways I can get the collection companies to work with me? I am willing to pay on these bills, but after all this time you would think they would work with people to get them off the books.
-- Nick M., Fort Wayne, Ind.

We’re not sure what you mean by “work with” you. No matter how old the debt is, you still owe it — unless you go to court, declare bankruptcy and have the debt cleared by a judge.

In some cases, you may also be off the hook if the statute of limitations applies. You should check with an attorney to see to see what the law says about your circumstances.

Of course, people can and do get into financial trouble beyond their control and find themselves unable to repay a loan. Some banks will renegotiate the terms — after all, getting paid late is better than getting paid never. But no lender is going to very receptive to this idea if you wait seven years to contact them.

The laws governing outstanding debt are pretty clear: if you borrow money, you're expected to repay it, plus interest, according to the schedule you agreed to. We get the same spam you do from shysters claiming to have found loopholes that "erase" your debts. Do yourself a favor and hit the delete key on these.

Lending is a business. When the lender originally decided to “work with” you — by lending you the money — they expected to get their money back. To be sure, banks and credit card companies to do a horrible job of spelling out  specific terms and conditions in writing, especially in failing to disclose a blizzard of hidden fees and nuisance charges. But the basic concept behind borrowing money is pretty clear.

Though there are laws and regulations designed to protect consumers from predatory lending practices, the terms of most loans are governed by a contract you sign when you borrow. If you have any questions about these terms (we're assuming you at least tried to read the contract), ask. If you don't get answers you understand, keep asking — or find another lender.

It turns out that many loan contracts include language that says if you don’t keep up with the payments, you may owe the full amount all at once. If those are the terms, it’s not unreasonable for the party now on the other side of the loan to try to collect in full. In any case, it sounds like the lender has sold off the loan (which they usually do for less than what you borrowed) to a collection agency. If that’s the case, the original lender is never going to get all their money back.

And unless you’re also getting hit with seven years worth of compound interest, you’re getting a good deal. Because of the effects of inflation, the 2006 dollars you use today to pay off your debt are worth less than the ones you borrowed in 1999. By paying the “full amount” of a 1999 loan with 2006 dollars, you’re really paying off only about 80 percent of the loan.

You may, in the end, be able to work out a payment plan. But we can understand how the person on the other end of the phone may be a little skeptical in dealing with someone who just walked away from a loan and waited seven years to start thinking about how they were going to pay it back.

It seems that the most effective economic export the U.S. has is warfare. We seem to be less competitive in other ventures, but war seems to be an economic winner for our society. Do I have that right, or are there other things we export as successfully? compared to Japan, Germany, China, etc.
--
Jon R., Chicago, Ill.

Blue jeans, jetliners, movies and video games come to mind.

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Data: Latest rates in the US

Home equity rates View rates in your area
Home equity type Today +/- Chart
$30K HELOC FICO 5.04%
$30K home equity loan FICO 5.67%
$75K home equity loan FICO 4.96%
Credit card rates View more rates
Card type Today +/- Last Week
Low Interest Cards 13.42%
13.42%
Cash Back Cards 17.94%
17.94%
Rewards Cards 17.15%
17.15%
Source: Bankrate.com