effects of higher interest rates

While higher interest rates can be beneficial for savers and lenders, as we discussed in our last post, there are also several drawbacks to consider. In this blog post, we will explore the impact of higher interest rates including some of the potential disadvantages.

Increased borrowing costs

One of the most significant impacts of higher interest rates is that they can lead to increased borrowing costs for consumers and businesses. When interest rates rise, it becomes more expensive to borrow money, which can reduce consumer spending and business investment. This can lead to decreased economic growth, as businesses are less likely to expand and hire new employees. In fact, the employment numbers and wage levels are key economic indicators the Federal Reserve is using to determine when and the degree to which they should raise rates. 

Higher interest rates can also have a negative impact on the housing market. When interest rates are high, fewer people can afford to buy homes, which can lead to a decrease in demand and a drop in housing prices. This can be particularly problematic for homeowners who are looking to sell their homes for those who are in the process of buying a home. In some cases, it leads to consumers feeling “trapped” in their current homes because they currently have low fixed mortgage rates. Because mortgage rates are so much higher than they were just a few years ago, taking out a loan of the same size as the original loan to buy a new house can lead to a drastically higher mortgage payment.

Declines in stock market

Another potential drawback of higher interest rates is that they can lead to a decrease in the stock market. When interest rates rise, investors may sell their stocks and invest in safer, fixed-income securities such as bonds. This can cause a decrease in demand for stocks, which can lead to a decrease in stock prices. In addition, higher interest rates increase the price that businesses pay to borrow. Businesses that rely on cheap money (low-interest rates for borrowing), they may be unable to sustain the growth that they’ve had. And in some cases, a company may not be able to continue operations if the money it borrowed was subject to floating or variable interest rates and the payments have now simply become too large for the company to continue making payments.

Higher costs

Higher interest rates can also lead to an increase in the value of the currency. When interest rates rise, foreign investors may be attracted to invest in the country, which can cause an increase in the demand for the currency. While this may seem like a positive outcome, it can also make exports more expensive, which can harm businesses that rely on international trade.

Increased national debt

Finally, higher interest rates can lead to an increase in the national debt. When interest rates rise, it becomes more expensive for the government to borrow money, which can lead to an increase in the national debt. This can have long-term consequences for the country’s financial health and can lead to a decrease in government spending on programs, including healthcare and education.

While higher interest rates can have benefits for savers and lenders, they also have several drawbacks to consider. These include increased borrowing costs for consumers and businesses, a negative impact on the housing market, a decrease in the stock market, an increase in the value of the currency, and an increase in the national debt. When considering the impact of higher interest rates, it is important to weigh both the potential benefits and drawbacks before making any financial decisions.

This article is intended to be educational and thought-provoking rather than financial advice.  When we work together in a financial planning engagement, we discuss your unique personal situation and your unique goals.  During our financial planning process, we examine these factors and many others to determine appropriate financial strategies for YOU.

Recommended Posts