Many people work hard in order to fulfill their aspirations of owning their dream home or buying a brand new car. To afford these, numerous consumers resort to borrowing from financial institutions such as banks, which impose interest rate on the said loans. When interest rates go up, the cost of borrowing increases. This means that should they decide to push through with purchasing the house or car this period their monthly amortization would be relatively higher. If the amortization amount goes beyond the consumer's budget, he/she may decide to defer buying the new house or car.
With this, it becomes evident that interest rate uptrend complicates borrowing decisions since consumers become confronted with the uncertainty if the said trend would prevail in the long term. As such, consumers usually suspend purchasing big-ticket items when interest rates climb. This may potentially lead to a contraction in the housing or automobile markets as well as in other industries.
On the contrary, an interest rate downtrend easily translates to a boom in the housing market and various industries for big-ticket items. A low interest rate environment augurs well with consumers, as they are encouraged to borrow in financing their purchases. This condition fuels consumption spending since consumers are driven by the relatively lower interest payments they would be potentially servicing every month.
Cost of Loans/Mortgages
For those who are currently servicing debt payments under adjustable rate mortgages (ARMs), jump in interest rates entail ballooning monthly payments. Given this, an upward movement in interest rate puts the period of full ownership of a house further over the horizon. This may even lead to payment default or property foreclosures for homeowners on tight budgets who may be having a hard time affording rising mortgage payments. In this regard, increase in interest rates creates a dent on income which results in lower spending of consumers.
However, on the upside, should interest rates go down then there maybe a downward adjustment on consumers' monthly payments. As a result, they are left with more disposable income which they could allot for other purchases.
Credit Card Purchases
Not only does an interest rate movement affect consumer spending for big-ticket items but also for ordinary expenditures such as groceries, utility bills and other household items among others. Since there are a considerable number of consumers who purchase using their credit cards, an increase in interest rates may lead to an uptick in credit card rates and the amount consumers have to pay for monthly credit card charges. With this, consumers who are not so liquid, i.e. those who do not have ample cash on hand, may cut back on credit purchases.
In the same way, consumers may perceive that lower credit card rates make them better off as they are able to derive "savings" from what they would have paid when rates were much higher. This goads them to spend more to take advantage of low rates.
Apart from spending, interest rates also affect consumer savings. With higher interest rates, consumers have greater incentive to save because their deposits may earn higher interest income. However, a low interest rate regime brings about disincentive to save. When interest rates slide, so does the