How Will Higher Interest Rates Affect Your Finances in 4 Simple Ways
Share this content :
Have you ever wondered how banks benefit from a loan? At first glance, the idea of giving away thousands of dollars in one go, with repayments slowly refilling that gap over years, might sound silly. However, banks, lenders, and other financial institutions rely on a powerful asset you’ve heard of before: interest.
In simple terms, interest is how much a lender charges you for any service or asset you buy. When you get a loan for one million dollars, you’re not paying back only that amount. Most likely, you’ll also be paying a certain percentage as well, such as 5% annually.
Now, you might be asking how will higher interest rates affect your finances. Though it might not seem so special or urgent at first, higher interest rates can be a costly venture. It can lead to more expensive loans or it can take grow in price over time. To help you avoid a financial nightmare, here’s how higher interest rates affect your finances and how you can prepare your money for it.
Types of interest rates
Before you can handle higher interest rates, you need to know what kinds there are. Some people might think that all interest rates are the same. However, there are various types that can affect how much you pay your lenders and borrowers. Here are some types of interest rates and what they mean.
Fixed Interest Rate
The most common type you’ll find, a fixed interest rate is the percentage that a borrower charges you throughout repayment. It’s usually straightforward and, depending on the lender, it can be negotiated upon. What makes this rate useful is that it cannot be modified under any circumstances. In other words, if you’re paying 5% per month, then you can easily calculate and prepare that money ahead of time.
Variable Interest Rate
A variable interest rate is the opposite version of fixed interest rates. Under this plan, the rate changes over time and usually grows above the baseline. Oftentimes, this plan is ideal for the borrower as it can lead to higher charges over time. However, they are also often lower in percentage than fixed interest rates. Plus, under the right conditions, a variable interest rate can lead to an earlier payoff of the loan.
Prime Interest Rate
Prime interest rates are the rates that banks charge to their “best” customers. These clients would usually have good credit histories or tenure with the banks. Compared to the average borrowing rate, these prime rates are the most rewarding options that an institution can give. It also serves as the benchmark for all other services, as well as other interest rate options.
Simple Interest Rate
As the name implies, simple interest rates are easy calculations of how much a client should pay over time. Typically, there are only three factors that these rates use: the principal amount, the interest rate itself, and the number of repayment periods set. This allows both client and lender to calculate how much a loan is worth.
Compound Interest Rate
Compound interest rates are more technical in nature. It uses a method called interest on interest to determine how much the annual percentage rate for each client’s payments will be. In other words, compound interest rates not only have interest rates for the principal amount but also get interest rates for the additional money. You can often find the effects of compound interest in savings accounts and in stock investments.
How do higher interest rates affect me?
Now that you know what types there are, you can see that interest can both help and harm your money. Investments can become a bigger payoff, but expenses and loans can also grow over time. If you’re still wondering how will higher interest rates affect your finances, here are six ways it will do so.
1. Debts and payments can cost more over time.
Depending on what contract you sign, higher interest rates might mean more expenses in the long run. If you have a variable or adjustable rate for your mortgage or loan, be wary of its changes. If the Federal Reserve bumps up the lending rate, then your repayments will have to adjust accordingly. In short, higher interest rates can add extra dollars to your monthly or yearly bill.
2. Investments can become more or less valuable.
If you’re wondering how will higher interest rates affect your finances, you might only be expecting bigger bills. However, under the right circumstances, it can lead to better payoffs. If you deposit money regularly or you’ve bought bonds, your investments could grow with the higher rates. It’ll lead to more cash in your pocket as the rate increases.
However, that scenario only works if you have a variable rate for your investments. If you have a fixed percentage for your bonds, the value will actually drop. For banks and other institutions, your money might not seem as useful as others.
3. Inflation rates could drop.
You might be wondering why the Federal Reserve modifies lending rates over time. To make a long story short, it does so to boost the economy and enable its growth. It can lower interest rates to help promote purchasing power for everyone in the country.
So, how will higher interest rates affect your finances under this idea? Higher interest rates are set by the Feds to try and combat inflation. Ideally, a higher rate will keep prices from rising too high. In effect, it also means that your money gains more purchasing power and can be more valuable over time. So, if you see headlines about inflation hitting hard, don’t be surprised if the Feds respond by raising the interest rate.
4. Stocks could become more affordable.
When it comes to investments, you might automatically think of the stock market. Here, you can buy shares from companies all over the country and see their value grow over time. It’s through this market that trading and investing become powerful tools, especially if they lead to big payoffs.
So, how will higher interest rates affect your finances through the stock market? As I said before, the higher these rates go, the more expensive stocks can be over time. However, not all stocks get that same treatment. Some might become undervalued and cheaper as time goes on. This can give you a chance to invest in quality stocks for a good price. However, always keep in mind that the investment game is for the patient ones.
You can get your stocks for a better price now but you might have to wait quite a bit before they grow in value.
In summary
An interest rate is the amount of money that you pay to your banks or lenders when you hold any financial transaction. Whether you get a loan or put in savings, interest rates can add more cash to the formula. There are many types of interest rates to consider, from fixed rates to variable interest plans.
If you want to know how will higher interest rates affect your finances, look no further than your investments. Debts and repayment periods can become more expensive as the rates grow. Stocks and bonds could also become more affordable or more valuable for trade. Plus, inflation rates can be mended so that you can get more power for your cash. What’s important to remember is that you monitor how much the interest rate could rise or fall. Knowing that can help you understand how to use your money wisely, especially if you need a loan or open a credit account.
- Ali, M. (2022, April 13). How Do Interest Rates Affect Your Finances? YouTube.
- Amadeo, K. (2022, January 29). Interest Rates and How They Work. The Balance.
- Banton, C. (2022, July 6). Interest Rates: Different Types and What They Mean to Borrowers. Investopedia.
- Chen, J. (2021, April 1). Variable Interest Rate: Definition, Pros & Cons, Vs. Fixed. Investopedia.
- Gailey, A. (2022, December 14). 4 Ways the Fed’s Interest Rate Hikes Directly Affect Your Money — and What You Can Do About It. NextAdvisor With TIME.
- Seabury, C. (2022, June 17). How Interest Rates Affect the U.S. Markets. Investopedia.
- Sonnier, M. Accessed on January 9, 2023. How Interest Rates Impact Your Wallet. 360 Degrees of Financial Literacy.
- Srivastav, A. K. (2022, September 29). Types of Interest. WallStreetMojo.
Share this content :
