BENEFITS TO HIGHER INTEREST RATES

By now, you’ve undoubtedly heard that “the Fed” has been raising interest rates to rein in inflation. Interest rates are an essential part of our economy, and their impact can be felt by nearly everyone who participates in financial activities. The federal reserve raises interest rates to restrict access to funds and hopefully slow down the rate of increase of prices, including wages, in the economy. While this sounds like an awful idea if you are a borrower or have used access to cheap money to grow your business, higher interest rates can positively affect savers and lenders. If you are a saver, higher interest rates mean you can earn more money on your savings. This can be really helpful if you are saving for a specific goal, such as buying a house, starting a business, or saving for retirement. With higher interest rates, your savings will grow at a faster rate, allowing you to reach your financial goals sooner. Another advantage of higher interest rates for savers is that they can help to combat inflation. Inflation is the rise in the cost of goods and services over time, and it can erode the value of your savings. In other words, if the prices of the goods you buy rise faster than the value of your savings, your savings can’t buy as many goods. However, if you are earning a higher interest rate on your savings, you can offset the effects of inflation and maintain the purchasing power of your money. For lenders, higher interest rates mean that they can earn more money on the loans they provide. This can be particularly beneficial for banks and other financial institutions that make a significant portion of their revenue from interest on loans. Higher interest rates can also encourage more lending, as lenders are more likely to provide loans when they can earn a higher return on their investment. And, when you purchase a bond, whether a government bond or corporate bond, you also become a lender and can benefit from higher interest rates. Retirees and others who live on fixed incomes are often savers and lenders—a large part of their income is often the interest generated from savings deposits and bond interest. After nearly a decade of extremely low interest rates, these new higher interest rates are a real boon to those living on fixed incomes. Another advantage of higher interest rates for lenders is that they can help to stabilize the economy.  When interest rates are low, borrowing becomes cheaper, and consumers and businesses are more likely to take on debt. However, this can lead to an increase in inflation and a potential economic bubble, and in some cases, poor management decisions. Low interest rates can allow a company which is either poorly run or may not have an economically feasible business model to continue operations simply by borrowing cheap money. By raising interest rates, lenders can discourage excessive borrowing and prevent an economic crisis. Higher interest rates will have a different effect on savers and lenders versus borrowers. Savers can earn more money on their savings, combat inflation, and reach their financial goals faster. Lenders can earn more money on loans, stabilize the economy, and prevent potential economic crises. While borrowers may have to curtail spending in order to accommodate the higher cost associated with borrowing. While there may be some drawbacks to higher interest rates, the benefits for savers and lenders are significant.

Note on on blog posts and newsletters: When we work together, we examine your particular financial picture and your particular goals. Blog posts and newsletter articles are not individualized advice. They are intended to be thought-provoking and to surface discussion topics for your financial planning. If you have questions about your financial plan, feel free to schedule a meeting. Your first meeting is complimentary.

IMPACT 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 some of the potential disadvantages of higher interest rates.

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.

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 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.

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.

Note on blog posts and newsletters: When we work together, we examine your particular financial picture and your particular goals. Blog posts and newsletter articles are not individualized advice. They are intended to be thought-provoking and to surface discussion topics for your financial planning. If you have questions about your financial plan, feel free to schedule a meeting. Your first meeting is complimentary.