As the global economy continues to recover from the COVID-19pandemic, many families and businesses are experiencing higher prices.

Global uncertainty has a direct effect on our finances.Let’s take the war in Ukraine as an example. The war has impacted gas prices and the cost of everyday items. 

The economic uncertainty the war creates also makes central banks’ decisions on interest rates trickier.

Just What Are Interest Rates?

Credit (or borrowing) is the most common form of finance.You can borrow money from banks and other lenders topay for education, buy a home, a car, or even an appliance.

An interest rate is the percentage of the principal the lender charges for the use of its money.

When inflation is predicted to rise above the inflation target, raising interest rateskeeps the current and predicted price surgesunder control.

So, What do higher interest rates mean?

Means Borrowing Becomes More Expensive

Higher interest rates cause an increase in the cost of borrowing.

For households, this could mean higher mortgage costs. Homeowners in cities with high-priced real estate could pay hundreds of dollars more on regular mortgage payments.

It’s not just mortgages, though. With higher interest rates, interest payments on personal, student, auto,and credit card loans with variable rates are more expensive. 

This will have a ripple effect on the economy (see below).

Would Mean Less Spending in The Economy 

Tighter lending standards mean that consumers will reduce spending.

With higher interest rates, consumers with loans will have to pay more interest to lenders. This consequently has a negative effect on their spending habits.

You see, consumers still have to pay their bills. Once those bills become costlier, households are left with less disposable income, consequently limiting the growth in consumer spending.

This impact of higher interest may not be immediate for most people, and it may encourage more folks to save because they receive more on their savings rate. However, an increase in savings rates is likely to be far outweighed by the declining value of money put away.

Less Spending Means Less Revenue for Companies

An increase in interest rates affects even businesses that don’t have loans.

When consumers have less discretionary spending money, businesses’ revenues and profits decrease. Businesses that deal with luxury products or services may be hit the hardest as one of the first expenses that consumers drop when they have less discretionary are luxury items.

High-interest rates also decrease the capital available to expand businesses, affecting supply. Businesses that can’t or don’t want to afford the higher payments defer projects that involve financing. 

This reduction in liquidity slows the economy.

Which Could Mean Fewer Jobs, etc.

If the economy shrinks too far, it could lead to a recession.

This affects not only consumers but also businesses, who cut back on spending for new equipment or recruitment, thus slowing productivity or reducing the number of employees.

Businesses may be forced to recommit their resources away from innovation and reinvestment.This will lead to increased unemployment. 

Ensure That You Budget for Higher Interest Rates (If You’re Taking on More Debt)

If you plan to take on more debt, it pays to budget for higher interest rates.

One way to cushion your savings is to create additional income streams.

This can include getting a second job, starting a part-time business, or looking for a side hustle. 

A budget will help you see where your money is going. So, create one and stick to it.

Conclusion

Higher interest rates can affect your finances in various ways, but you can beat the odds and come out on top with careful planning.