Everything runs in cycles. Think about it – the human life cycle, nature, finances and economics are all cyclical. Current interest rates have been low for some time now. The Federal Reserve has kept them low to spur the economy. But this period will end shortly. How will higher interest rates affect you the consumer? Who will benefit and who will not? Who are the winners and losers in this situation?
First, borrowers are the ones that would be negatively affected by increasing interest rates. Applying for mortgages, credit cards, personal and business bank loans will affect you adversely. The cost of debt will rise. The cost of purchasing consumer goods will rise in order for producers to cover their costs. This rising costs could spur inflation.
Then, lenders benefit from increased rates. These could be banks, investors and the holders of interest rate sensitive instruments. Bondholders are other such lenders. They lend their money and receive interest in return. There is an inverse relation between interest rate and bonds. As the rates increase, the prices of bonds decrease. Lenders such as banks increase their rates as their cost of their borrowing goes up.
These are only a few examples. As you can see there is a cycle here. There exists a symbiotic relationship between borrowers and lenders. They follow the economic principle of supply and demand. As interest rates rise, costs go up which affects the inflation rate. The Federal Reserve watches inflation rates very carefully. The last thing they want is run-a-way inflation. When the economy starts heating up, they can tighten the monetary policy causing interest rates rise.
What can we learn from an increasing rate environment? How can we protect ourselves? First, realize that it is a real probability. Second, if you need to borrow think about applying for it before rates go up. Most important, try to limit your borrowing, and becoming more liquid. This means reduce spending by being selective of your purchases. There are numerous benefits to reducing spending:reduce credit cards usage to save interest charges, decrease your debt, and increase your net worth. Without burdening debt you become less anxious, more independent, and are able withstand future economic crisis.
Brenda Hendrickson 