Impact of a Sharp Rise in Interest Rates on Households


Interest rates can be defined as the rate at which borrowers pay interest on money borrowed from lenders.   Interest rates in the United Kingdom are determined in part by the Bank of England base rate.   A rise in the Bank of England base rate will lead to a rise in interest rates.   In general, high interest rates lead to an increase in the cost of borrowing throughout the economy and also increase the return on money saved in interest bearing accounts.   A rise in interest rates would have a significant impact on household spending.   High interest rates are likely to affect:

1. The cost of repaying existing debt
2. The cost of obtaining new credit
3. The decision to save.
4. Consumers expectations and confidence.

1)The cost of repaying existing debt:

The rate of interest varies when the Bank of England changes base rates.   This is especially true for variable rate mortgages and loans where the interest rate changes over time in line with changes to base rates.   If there is a large rise in interest rates, the repayments on variable rate mortgages increases significantly.   For many households, rising interest rates would mean that funds would have to be diverted away from other forms of spending and redirected towards mortgage repayments.   The increased cost of mortgage and loan repayments might impact households with a sole bread winner.   In these circumstances,   home makers and carers may be forced to go into employment to increase the household income.   Households with retired individuals might have to return to employment and those approaching retirement are likely to continue working beyond retirement age.   The increased cost of repaying existing borrowing would impact the household balance sheets.   There would be a decrease in liquid assets as funds are directed towards growing liabilities like loan and mortgage repayments.

2)The cost of obtaining new credit:

Higher interest rates increase the cost of borrowing and make it more...