Customers are bracing themselves for an interest rate increase. They are anxious, nervous, and worried for what this means for them. And with talks of another increase happening soon, and more to come, customers are rightly worried. What are you doing to re-assure your customers you are in this together?
How inflation affects interest rates.
Let’s first take a look at why this is happening. The cost of living has increased so much, so fast, the Federal Reserve is stepping in to assist. Consumer prices rose in May at the fastest pace in 40+ years. This will likely force the Fed to raise interest rates several more times in the coming months. Fed officials may even resort to additional large rate increases in a bid to cool off inflation.
The Consumer Price Index (CPI) notes this both directly and indirectly affects the interest rate. The CPI is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The CPI reported that from May 2021 to May 2022, the Consumer Price Index for All Urban Consumers increased 8.6 percent, the largest 12-month increase since the period ending December 1981.
Higher Interest Rates change the way people borrow money.
Every time the Fed raises rates, it becomes more expensive for consumers to borrow. That means higher interest costs for mortgages, home equity lines of credit, credit cards, student debt and car loans. This is one way the Fed speeds up or slows down the economy by moving interest rates higher or lower; hopefully lessening the cost of inflation. But this also puts a larger strain on those who have borrowed money.
As CBS news reported, Americans will initially experience this policy shift through higher borrowing costs. It is no longer incredibly cheap to take out a mortgage or car loan. The most tangible way this is playing out is with mortgages, where rate hikes have already driven up rates and slowed down sales activity. The rate for a 30-year fixed-rate mortgage averaged 5.23% in the week ending June 9. That’s a drastic change from being under 3% this time last year. Potential borrowers are feeling the stress of increased payments as they look to purchase a home.
As PocketSense states “a slowdown in consumer spending slows down inflation because sellers have to lower the prices of goods in order to make sales in an environment where consumers have less disposable income due to more of their money going to borrowing costs.”
Good news on the horizon.
There are a few advantages to the increased rates. One small upside is the cash sitting in their savings accounts will finally earn something. It may not be that significant, but it is a start. That savings should increase as the interest rate increases, and so will consumers hope.
Also, the rapid rise of inflation should slow. The cost of goods will hopefully slow their steep incline. As Investopedia puts it “A stronger economy means more consumers seek loans, helping banks as they benefit from the difference between the interest they charge investors for the loan and the amount they earn by investing that money.”
With interest rates increasing, so does the profit banks make on loans. There is a larger difference between the federal funds rate that banks pay and the rate the bank charges its customers. The spread between long-term and short-term rates also increases because long-term rates tend to rise faster than short-term rates. This is good news for the financial services industry, but they must keep in mind that there will be a decrease in customers applying for loans.
Borrowers will look to financial institutions for assurance they will get through this, and that things will be OK. Be open with your consumers. Explain to them the benefits they should see from the higher interest rate. And be sympathetic to those that may start struggling with the increased rates on the mortgages and loans.
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