The Fed just announced recently that they were raising interest rates. We hear a lot of talk about that interest rate change, especially over the last few years and we have seen interest rates creep back up. I thought that I would provide an explanation of what that means, beyond the basic understanding that money becomes more expensive.
When the Fed raises interest rates even .25%, it can and does have significant effects on the economy. Here are some key ways in which the economy is affected by a hike:
- The cost of borrowing increases, this is the first thing that comes to mind. Consumers get nervous that they will get stuck in higher interest rates. It makes sense, the Fed raises interest rates, and it becomes more expensive for individuals, businesses, and banks to borrow money. You can bet when it costs the bank more money, that pain is passed right down to us. This can discourage borrowing and spending, as well as slow down economic activity.
I’m not in the finance space, but I think it’s good information for all of us to have as it relates to borrowing. I have said before, and in recent shows and blogs, that there are a couple of things that matter in any deal that you enter into, and at the top of that list is what we refer to as the cost of money.
What does it cost me to finance this house—I am not talking about the purchase price. I’m talking about that mortgage, what is the real cost? What am I really paying for this house, what is the total of the monthly payments that I will make over the 30 years of that loan?
It may be useful to provide a detailed example of the cost of money, and because I’m in the credit business I want to provide two.
$500,000 mortgage amount, here’s how the cost of a 30-year mortgage at 5.25% interest rate compares to a 30-year mortgage at 6% interest rate:
A 30-year mortgage at 5.25%:
- Monthly payment: $2,765.14
- Total interest paid over 30 years: $614,049.92 (that’s the cost of the money)
- So you add the 614,049.92 to the $500,000 mortgage and the total cost of the mortgage: $1,114,049.92
A 30-year mortgage at 6%:
- Monthly payment: $2,998.87
- Total interest paid over 30 years: $719,594.80 (that’s the cost of the money)
- The total cost of the mortgage: $1,219,594.80
So when we talk about buying $500,000 oftentimes, we get stuck on monthly payments, but the cost of money on that deal is over $100,000.
A hundred grand. And yes, your 500,000 home never costs you 500—it costs you 600k in interest at the low rate. The total interest you are paying is 100 grand over the purchase price of the home.
2. Increase in savings: When interest rates go up, it can encourage people to save more money in deposit accounts and other investments that offer higher returns. This can lead to a decrease in spending, which can slow down economic growth.
3. Appreciation of the currency: A rise in interest rates can lead to an appreciation of the currency, as investors are attracted to higher yields on investments in that currency. This can make exports more expensive and imports cheaper, which can hurt domestic businesses and industries.
4. Decrease in stock prices: Higher interest rates can also lead to a decrease in stock prices, as investors may shift their money to bonds and other fixed-income investments that offer higher returns.
5. Decrease in inflation: One of the primary goals of raising interest rates is to curb inflation. When the Fed raises interest rates, it can make it more expensive to borrow and spend money, which can help to slow down inflation.
Overall, the effects of raising interest rates can be complex and far-reaching and can have significant impacts on the overall health of the economy.
About Harry Jacobs:
Harry Jacobs is the Founder of Credit Restoration of Nevada. He is widely regarded as one of the experts in the field of credit, credit repair and credit restoration. His knowledge of Fair Debt Collection Practices and the Fair Credit Reporting Act make him a tremendous resource for consumers and consumer law firms.