Interest rates are at the heart of many financial transactions. From securing a mortgage to building savings in a bank account, understanding how interest rates work can help individuals manage their personal finances. Interest rates are also critical to the broader economy, impacting consumer spending and investment activity.
When interest rates are lower, people are more willing to borrow money and spend. This boosts economic growth by encouraging consumers to make big purchases that may not be within reach otherwise, such as a home or car. Low interest rates also encourage businesses and farmers to expand operations by lowering the cost of borrowing.
As interest rates rise, they reduce the amount of credit available and slow the economy’s pace of growth. For example, when interest rates increase on mortgages and credit cards, the cost of borrowing increases, so borrowers are less likely to take out loans. This, in turn, reduces overall spending and can cause companies to postpone investments.
But when it comes to investing, higher interest rates don’t necessarily mean that stocks will decline. Some sectors tend to do well when rates are rising, especially banks and other financial institutions. In addition, mortgage and insurance companies can benefit as customers who have variable-rate debt like credit card balances or adjustable-rate mortgages will see their payments increase. Investors in bonds can still earn income even when rates are high, since bond prices generally move in an inverse relationship to interest rates (that is, when rates go up, bond prices go down). Of course, it takes time for the effects of interest rate changes to kick in and impact the broader economy.