Login with Facebook

What happens if the interest rate increases?

Increasing the interest rate is not good news for consumers, mortgages and loans cost more. But there are also opportunities like yields on bonds and government bonds are growing. For some years now, we had grown accustomed to very low-interest rates to historic lows. The economy is struggling to recover, and showing worrying signs of recession needs low rates to stimulate recovery. When borrowing costs too much, people don't borrow money to make purchases, and businesses also avoid investing. In this way, the economy cannot grow. When, on the other hand, interest rates are low, it is easier to take on debts and be able to repay them. The mortgage installments will be lower, and so will the consumer credit installments because all types of financing are based on interest rates. With rising rates, the installments of new mortgages and loans become more expensive; only those who had previously contracted a fixed-rate mortgage are saved. So you are forced to give up financing because the cost to pay is too high compared to income. 

The cost has increased; the installment we have to pay for the loan goes up. If it is too expensive, we can no longer afford the loan or mortgage. If we have already had it, there are difficulties in repaying. We must regulate ourselves in the choices and financial planning and know first what if the interest rate increases? What does it mean for our savings, for consumption, and if there are opportunities for convenience when we go to ask for a loan. In fact, if we are savers, the rise in rates entails greater possibilities of return and, therefore, of profit from our investments. 

If we lend money instead of borrowing it, rate hikes can be good news. So let's see what the interest rate is, when and why it drops or goes up and what consequences these movements have on our habits and financial decisions. Is it possible to predict and anticipate the movement of rates? How should you invest in a rate hike period? Which securities to buy, which to keep or sell? It is appropriate or not at this time to ask for a mortgage for the purchase of a house or a loan for consumer goods. Let’s have a look at what happened if the interest rate increases.

What is the interest rate and what does it measure

The interest rate is the cost of the money that lends itself. Those who offer money want compensation, I give you 100 today, and you will return 105 in a year. That is to say; you will repay the principal I have lent you plus 5% interest, which represents my remuneration for having lent you the money and having waited for its return for a year.

This is why the interest rate is also called the “price of time. " The longer the loan period, the higher it’s cost because those who have lent themselves will be paid more for having renounced the availability of their money for a longer time. 

It is necessary to give them adequate remuneration to convince people or businesses to lend their money to banks or the State. The interest rate measure and this price increase with the increasing duration of the loan. With the same amount, a term loan of five years will serve a higher interest of a repayable in two years. Even if the installment in the first case will be lower, the total amount that will be returned will be higher.

Each period of time has its own rates; there are short-term and long-term rates. Usually, the longer the deadline, the higher the rates applied.

The bank convinces savers to deposit their money by offering a certain interest to make it cheaper to use it in this way rather than keeping it under the mattress or investing it in other ways, such as buying real estate or equity investments in companies.

The State also offers its public debt securities on the market to finance itself and, in exchange, promises the subscribers to repay the capital plus a certain interest.

But how is this interest determined? Its rate is determined based on another fundamental value, which is the inflation rate.

Nominal rate and the real rate

The congruity of an interest rate - that is, its effectiveness in measuring the cost of our loan or the return on our investment - must be measured, taking into account how much inflation has grown in the meantime. We refer to the future, that is, if we want to evaluate the convenience of a loan to be requested or an investment to be made now, and which will last a few years, we must relate to the expected inflation.

The interest of 15% per annum seems high, but if inflation in that year were 20%, we would not have gained at all, but we would have lost 5% of our capital.

In the end, in fact, the sum of 115 would not be enough to cover the inflation that had accrued in the meantime. They raised prices to buy the same things for which the year before we needed 100 dollars, now we need 120, and we only have 115.

Our money will have less purchasing power, that is, with that amount you will be able to buy fewer goods because their prices have grown because of inflation.

It is necessary to distinguish the nominal rate from the real rate, that is, the rate excluding inflation.

To calculate the real interest rate, it is necessary to subtract the inflation rate from the nominal interest rate, that is, the one agreed or promised in the loan agreement or in the subscription of the bond. If our bond makes 5% per annum and inflation it is 2% per annum, the real interest rate will be 3%.

From here, we have the measure of the true cost of our loan or the actual return of our investment. The good news is that the growth of interest rates at this time is not accompanied by a similar increase in the inflation rate. We will pay more for the money we borrow, but on the other hand, we get a higher real remuneration if we lend it, to invest it in financial products. This investment guarantees an adequate return in real terms.

When and why does the interest rate go up?

Rates rise (or fall) when economic conditions vary, and the economic and political scenario changes. The factors are many such as corporate health, political tensions, and employment trends. In a nutshell, when the risk increases (not only the real one but also the "perceived," i.e., the fears), the price that money lenders ask for increases the interest rate.

We have seen that if rates go up too much, the capital holders are no longer willing to lend it. Even the loan applicants are not willing to pay too high interest, and all this is bad for the growth of the economy. For this reason, central banks intervene with all the tools available to them to keep rates as low as possible or at least to an acceptable level. They intervene on interest rates mainly on the basis of inflation trends. When this tends to rise, central banks raise interest rates to discourage expenses; in this way, financing costs more, and it is more difficult to buy products such as cars or household appliances. 

Thus consumption decreases, and prices do not rise. On the other hand, when inflation falls, they lower rates to encourage purchases, consumption, and investments.

This is what has happened in recent years; both the ECB (European Central Bank) and the FED (the US Central Bank) have adopted policies that have "forced" all banks and financial operators to keep the interest rates applied to customers within certain limits.

Central banks have acted on the interest rates of government bonds, which are mainly purchased by financial institutions. Their yield over the past three years has even been negative with regard to short-term ones.

In this way, we wanted to discourage the use of capital in "safe" government bonds to divert it towards loans and, therefore, investments and consumption that bring economic growth. Above all, the European Central Bank, with the presidency of Christine Lagarde., has decided to adopt this extremely low rate policy to encourage banks to lend money to businesses and families. However, there have been recent warnings, even official ones, that this policy so far held by central banks is about to end. There is a danger that rates may rise in the near future.

In fact, as the markets anticipate trends, there has already been a generalized growth in interest rates, mortgages, and loans cost more than in the recent past. Also, the yields of government and bond securities have gone up. We must evaluate how to behave in this scenario whether you are a consumer or an investor. You need to know what the right moves to make are if you decide to apply for a mortgage or a loan for the purchase of a consumer good or if you intend to invest your savings in bonds or government bonds. 

Before going into detail, remember well this concept, interest rates are very sensitive to the trend of inflation. So when this goes up, the rates go up, and vice versa.

So far, central banks have tried to counter the rise in inflation using the weapon of interest rates, which have been kept very low through a specific monetary policy, which will probably not be continued in the future. Interest rates could go up, and we have to deal with this eventuality, especially considering whether it is better to get into debt or invest now or to wait.

How to invest with rising rates: risks and opportunities

The increase in interest rates represents a risk for those who have borrowed money and will have to pay more when they return it, while it is an advantage for those who offer it. We often forget that it is not only banks that offer loans that lend their money, but also individuals who invest their savings. They, too, offer their capital to those who request it, such as companies that issue bonds or even the State itself, which periodically auctions its securities.

So you too, if and when you buy a government bond or a bond issued by a company, are lending money, and in return, you will have an interest rate as remuneration. It will measure your earnings and the return on your investment. The market conditions of that moment are expressed by the trend in interest rates. It is measured daily and periodically, 3 months, one year, 5 or 10 years, and even at 30 or even 50 years. Each of these periods has its own index, which measures the trend of interest rates.

As government bond auctions show (at least a couple of them a month), interest rates and returns are very fluctuating over time. 

So, in the same way, if you request a quote for a loan today and then return after a few months, you may find that the conditions have changed considerably. The increase in interest rates has changed, in practice, the number of installments to be paid. Sometimes the amount to be repaid has grown so much, compared to your income and your assets, that you are forced to give up the loan because you would not be able to repay it.

Let's now look at these two aspects in more detail. If you are on the side of those who need to request money on loan, you will need to know the consequences of rising rates on mortgages. While if you are on the side of those who want to invest in bonds and securities, they will be useful to know the factors that can increase your expected return.


Have you any questions? Let us know in the comment box. And for business essayinterest rate increases, don’t hesitate to Order Now.


Comments




Send Comment

Need a custom
essay?

We will write it for you.
Order now

Free Essay Examples

Free essays:

Analysis of Consumption and Investment
Analysis of Business Cycles
Analysis of Fiscal and Monetary Policies
An Overview Of Economic Studies
Biosensors for cancer diagnosis
Business Analysis: Pricing strategies and Demand Curve
Broadcasting: How to Be Good In Front of the Camera
Bioconjugates for the Drugs Delivery
Cells of Immune system
Challenges that IT Managers are facing
Cochlear implant: what it is and how it works
Current challenges to the health of women
Doppler ultrasound or simply eco Doppler
DNA extraction
Dynamic Systems Modeling with Machine Learning
Digital Imaging: What Is It?
Economy analysis: Business Cycle and Economic Trends
Exchange rate and foreign currency risk
Economic Factors Affecting Decision Making In A Business
Economy Analysis: Inflation, Unemployment And Policies
Factors Influencing Interest and Exchange Rates
Fiscal and Monetary Policies in Response to 2008/2009
Fermentation: how it works and what it is used for
Financial Markets and Functions
Genetic regulation networks: modeling in biology
How does the economics of war affect society?
How can immigrants blend in the American society?
How to make your business survive at economic crisis
Importance of corporate sustainability
Interaction of Consumer and Firm Choices in Markets
Introduction to Microeconomics
Introduction of Microfabrication techniques
Journalism: What is News?
Journalism: Broadcast media and Television Presenters
Journalism: Sources of News
Journalism and Law
Key Determinants of National Income
Key Factors That Affect Pricing Decisions
Kinetic models in biology and Related fields
Know about the different forms of traditional African dances
Latest technology trends
Latest dance trends
Methods of labeling of nucleic acid that enable their detection
Macroeconomics: International Economic Issues
Neuromuscular disorders
National Economies, Fluctuation, and Responses to Fluctuations
Neurotransmitters: what they are and different types
Nanomedicines to target tumors
Overcoming Hiring Challenges for Nonprofit Organization
Principles of Microeconomics - Producer Theory
Principles of Microeconomics - Consumer Theory
Principles of Economics
Role of media in wartime.
Role of technology in the modern business environment
Role of Homeostasis in Human Physiology
Role of a digital artist
Skills in Journalism: Effective Interview
Systems biology - An understanding the functioning of biological systems
Self-assembly for biological systems
School of American Ballet
Types of corporate responsibility
The Role of Government Policy in Improving Economic Outcomes
Types of bioreactors and their applications
Technological perspectives and reflections of neural engineering
Understanding Perfect and Imperfect Competition
Ultrasound: physical principles and image formation
Understanding social entrepreneurship
Understand the importance of investigative journalism
Various theoretical perspectives of sociology
Virtual reality, what it is and how it works
What is MBA with Concentrations
What are the Causes of financial instability?
4 Facts about Origin of Mathematics!
5 techniques to create an animation
10 strategies to maximize corporate profits
13 Best colleges for political science in the world
6 Medical Technologies that revolutionized the healthcare in 2020
All you need to know about the ACA Code of ethics
Architecture and Democracy: An Introduction
Architecture and Democracy: Democratic Values
Architecture and Democracy: Democratic Procedures
All You Need to Know About a Synthesis Essay
An essential guide to understanding Film Theory
Application of Artificial Intelligence in Cyber Security
Applications of electrical engineering
Augmented reality: what it is, how it works, examples
Advantages And Disadvantages Of Social Networking
All you need to know about Cryptography
Applications of astrophysical science
All you need to know about architecture engineering
Applications of geological engineering
Artificial intelligence and medicine: an increasingly close relationship
An insight into Computational Biology
ACA code of conduct
A Rose for Emily
Applications of Mathematics in daily life
Architecture mistakes to avoid
All you need to know about Toxicology
All you need to know about Holistic Medicine
All you need to know about linguistics
An introduction to Linguistics and its subfields
All you need to know about Anxiety disorder
All you need to know about Drones
A Brief Insight into Political Science
Assumptions related to feminism
All you need to know about Byzantine emperors
All you need to know about labour economics
An insight into xenobots -the first-ever robots
An ultimate guide about Biomaterials
A Comprehensive Introduction to the Mona Lisa
Analysis methods of Transport through biological membranes
An ultimate guide about biochemical reactions
Analysis of brain signals
Artificial Gene Synthesis
Application to synthetic biology of CAD methods
All you need to know about metabolic pathways
Applications of BIOMEMS
All you need to know about the epidemiology
Asian vs. western leadership styles
All you need to know about Smart prosthesis
Analysis of Economy: Output of Goods and Services (GNP), and GDP on Economic success
A Guide to Pricing Strategies
An Overview Of Economic Studies
Analysis of Fiscal and Monetary Policies
Analysis of Business Cycles
Analysis of Consumption and Investment
How to Write a Personal Essay
Housing Needs in America
How to Write a Description Essay
How to Create an Excellent Scholarship Essay?
How to write a cause and effect essay
How to Hire the Best Essay Writing Service Provider?
How to Write a College Application Essay?
How to get the most out of your English lectures
How to write Expository Essay
How to succeed in your psychology class?
How to Write an Academic Essay in the Shortest Time?
History of Journalism
How Different Sectors are Using Artificial intelligence (AI)
How to write an informative essay
How to deliver persuasive essays?
How to Give a Convincing Presentation
How to write an essay on leadership?
Historical Art Still Around Today
Humanoid robot: what it is, how it works and price
History of Chemistry
Healthcare Advanced Computer Power: Robotics, Medical Imaging, and More
Healthcare AI: Game Changers for Medical Decision-Making and Remote Patient Monitoring
How to understand different types of English
How to Cope with Chronic Pain
How African American choreographers and dancers have influenced American dance
How mobile robot can do in logistics or in production
How To Become a Successful Entrepreneur
History of the Philosophy of Feminism
How is the climate changing?
How to Track Your Content Marketing ROI
How to Gun control In the USA?
Historical and contemporary role of labour in the modern world
How breast cancers are classified?
How the cells of our body communicate?
How the Lymphatic System Works?
How Digestive System Works
How to complete your capstone projects effectively?
How to write a research project
Healthcare technologies that help patients with better self-management
How to choose the topic of the senior capstone project
How to make your business survive at economic crisis
How can immigrants blend in the American society?
How does the economics of war affect society?
The Looming Energy Crisis in America
Top benefits of performance-based engineering
The More Languages You Know, The More Times You Are a Man
Things to consider while writing an Argumentative Essay
Top Ways to Improve Your Academic Writing Skills
Tips to Excel in Creative Writing
The origins of films in the early 19th century
Top career options in Architecture
The Elevator Pitch
Top finance trends 2020
The basic Structure and functionality of robots
The Way to Success
The election system of the President in the United States of America
Two-party System in United States of America
Top trends in urban design
The history and theory of African American filmmaking
Top benefits of creative writing
Tinnitus Guide: Common Symptoms and Treatment Options
The language of dance
The digital image processing management
Top famous politicians of the World
Top methods of political science!
The history of the feminist movement
The blood flow in cardiovascular system - Biofluid Mechanics
The best of Leonardo Da Vinci
The Structure and Function of Macromolecules
The structure of cell: a research on the bricks of the human body!
Tissue and organ construction: Adhesion and recognition between cells
The kinetics of the transformation processes
The Modeling of Biological Systems
Tips for writing a great thesis statement
The Defense mechanisms against infections
The impact of the technological innovations in medicine
Top journalism trends to know about
The relation between mass media & politics
Theranostics: Diagnosis and Care through Nanoparticles
The practical Applications of X-rays
The applications of Ultrasound in medicine
Transfer mechanisms of genetic information in Bacteria
The regulation of cellular metabolism in the diagnosis
The Principles of MRI Contrast agents
The technical basis of optical coherence imaging
The New Media: Emerging Trends
The Structure of Interest Rates and the Yield Curve
Technological perspectives and reflections of neural engineering
Types of bioreactors and their applications
The Role of Government Policy in Improving Economic Outcomes
Types of corporate responsibility
What is a Definition Essay?
What are diagnostic essays?
What is the relation between art structural engineering?
What is a Narrative Essay
What are robotics and intelligence systems?
What are the benefits of studying health sciences?
What is artificial intelligence and why it matters?
What is comparative Literature?
Why study neuroscience
What is Wi-Fi and how does it works
What is French history famous for?
What are Humanistic Studies?
What is covered in Biophysics?
What is modern journalism?
What is Virtualization? Benefits & Applications
What are modern public relations?
What is plasma physics?
What is teacher preparation?
What is rapid prototyping for 3D printing?
What is contemporary European Politics?
Why should you learn American Ballet?
What is engineering physics?
What is the purpose of African American Literature?
Ways to learn the Rhythm
What is digital art used for?
What are Enzymes and how do they work
Who is the father of political science?
Why Study Political Science - Job?
What is the Philosophy of Feminism?
What is a quantum computer?
Ways B2B Startups Streamline Their Conversion Strategies
Why do biomedical signals need processing?
What are the long term effects of climate change?
Why study labour relations
What is Holoprosencephaly?
What is antisocial disorder?
What are the important principles of evolution?
What is the cytoplasm and its function?
What is biopolymers?
What Makes a Good Leader
Women empowerment in modern generation
What is the history of political thought?
What is Gene recombination
What is synthetic biology
What is business cost analysis?
What is Inflation
What are the consequences of unemployment?
What is lithotripsy and its types?
What is transition elastography?
What is the purpose of deep brain stimulation?
What is a Brain-Computer Interface (BCI)
What is neuroethics?
What is Market and Supply and Demand
What is optogenetics?
What are the techniques to record brain activity?
What happens if the interest rate increases?
What is immunotherapy?
What is the economic role of the financial market?
What are the factors behind illegal immigration?
What is the lymphocyte activation?
What is financial market and its types?
What is the structure of financial markets?
What are the methods of measuring business performance?
What is the Credit market?
What is business ethics and code of ethics
What are the Causes of financial instability?
What is MBA with Concentrations