Interest rates represent the cost (or benefit, in case of lending) associated with borrowing money, typically expressed as a percentage of its principal amount.
Rising interest rates increase the cost of borrowing, which should help curb consumer spending and promote savings. Rising rates also provide stronger incentives to savers by raising annual percentage yields on savings, checking, and certificate of deposit accounts.
Increased Costs of Borrowing
After more than a decade of historically low interest rates, interest rates are on the rise due to efforts by the Federal Reserve to curb inflation. Interest rates impact everything from home and car financing costs to debt payments for credit cards.
As rates increase, borrowing money becomes more costly for consumers and the economy as consumers lack as much disposable income to spend on goods and services.
As a result, businesses may also slow their expansion as they take on more costly loans to fund operations. But by actively managing debt and savings accounts and adapting your budget accordingly, the impact on finances should not be too significant; what goes up will eventually come back down; while in the meantime you’ll earn higher returns from your savings investments than before; something which should not be seen as negative!
Increased Costs of Savings
Most people understand that rising interest rates generally translate to increased borrowing costs, yet many remain unaware of all of the ways changing rates can impact personal finances.
As an example, when the Fed raises rates it often leads to savings products like money markets and certificates of deposit providing higher annual percentage yields, helping savers earn more with their money. It may also lead banks to charge variable-rate customers more when borrowing such as credit cards or home equity loans from them.
At a national level, when consumers save more, they may be better equipped to deal with financial hardship and unemployment more quickly, helping the economy recover faster from economic downturns. Individuals should remember the lessons from past economic cycles by maintaining high savings rates even during times of high borrowing rates – this will ensure they’re ready for future challenges that might come their way.
Decreased Disposable Income
As interest rates increase, your disposable income – the money left over after taxes to spend or invest – decreases. Economists use disposable income as an indicator to calculate various metrics such as personal savings rates and marginal propensities to consume/save ratios.
Your actual disposable income may differ from that reported due to mandatory deductions like state and local sales taxes, retirement contributions and court-ordered child support payments. Furthermore, the net pay figure on your paycheck does not take into account expenses such as rent, utilities and groceries.
Interest rate hikes tend to make financing purchases such as cars and homes more costly, driving up product and service prices and slowing consumer consumption. On the bright side, rising rates can bring higher earnings from cash deposits like savings accounts, money market accounts, CDs – something consumers who own real estate can use as motivation to hold onto existing mortgages for longer.
Increased Risk of Inflation
As interest rates increase, so too does the risk of inflation. Inflation occurs when cash in an economy exceeds what can be purchased with it, leading to price increases and eventually leading to recession. If left unchecked, however, inflation can lead to drastic effects and cause severe harm for an economy.
Though some inflation is necessary for economic development, runaway inflation can be extremely dangerous and should be controlled by the central bank. Unchecked, high inflation can strain an economy’s resources while devaluing people’s savings due to decreased purchasing power of their money.
Understanding interest rates may seem complex, but understanding them is critical to safeguarding your financial future. With increased knowledge comes greater insight into how interest can impact investments and wealth management decisions – so when saving for retirement or purchasing a car be sure to consider how increasing interest rates could alter costs and savings.