As the economy continues to transition into recessionary conditions, interest rates have subsequentially begun to rise. The FED reported their first increase in rates last year since 2018, and there seems to be no indication of this rise slowing down. So, how does this increase affect individuals and businesses seeking to acquire loans? First, let's review different reasons an individual or business owner may need to seek additional funding.
One reason an individual will seek bank funding is to achieve the American dream of owning a home. Unfortunately, rising interest rates seems to be thwarting this dream for many Americans. The increased monthly payments an individual or family will incur at today’s higher interest rates makes the choice to buy almost counterintuitive.
In addition to the higher monthly cost to buy, potential homeowners are concerned with losing equity on high ticket purchases, like a home, within a few years if this recessionary environment continues. The choice to buy a home is already a big decision, but with these factors in play, many Americans have chosen to hit the pause button until they see a decline in interest rates. As a result, the coming months may show an increase within the rental market, much like the recession of 2008.
Individuals who are not looking to buy a home may consider buying a vehicle or taking out a personal loan to consolidate debt and take care of projects around the home. Purchasing a vehicle at this time will present similar challenges to those buying a home. With increased interest rates, consumers are faced with paying much more for a vehicle over the loan period than the vehicle is even worth. Additionally, they face potential future financial discomfort paying a higher monthly car payment.
Personal loans for debt or projects almost seem counterintuitive when faced with high interest rates. If you are looking to get a loan to help with debt, you face getting an interest rate that is higher than you currently have, please be sure to review your current loan packages. Taking on a new project for the home can be put on the back burner rather than growing debt at a high interest rate at this time.
Businesses have several reasons why they seek funding, but a key reason would be to foster growth within the company. Loans can go towards operational expenses, marketing efforts and adding more personnel. However, rising interest rates during a recessionary period could negatively impact a business seeking funding.
It’s almost a “catch 22”! As a business may need additional funding to facilitate their growth, a slowdown in the economy could also mean a slowdown in their business, resulting in reduced cash flow and difficulty paying back at a higher rate.
As difficult as these conditions are for businesses, there are some conditions where they could benefit from the rise in interest rates. For example, if a business has negative capital (excess cash on the balance sheet), they might be able to net a return from rising interest rates.
Recessionary conditions will also benefit businesses with a positive cash flow. It creates an opportunity for positive investment in securities, which can yield a higher return. The benefits may not apply to every business, so business owners and other borrowers must take the necessary measures to protect their business during this challenging period.
Good news is, our business landscape is different than the 2008 environment, affording businesses to seek creative financing options outside of the traditional funding when needed. Options can range from seeking the help of angel investors to crowd funding. In exchange for convertible debt or equity ownership, an angel investor will “invest”, or provide capital to your business with agreed upon terms between the investor and the businessowner. Unlike an agnel investor, crowd funding, gathers capital from various “investors” through donations. Popular crowdfunding sites include GoFundMe, KickStarter, JustGiving, and even Facebook.
The Big Question: Why are Interest Rates Rising?
The big question on everyone’s mind is, how did this happen in the first place? Why are interest rates on the rise?
Consumer inflation has increased to 6.5% which is fairly high considering recent year’s rates. This signals to the government and the Federal Reserve to “cool the economy”, or slow consumer spending - thus, resulting in an increase in borrowing rates. There is no determined end in sight now as the country is still experiencing high inflation, but Americans should buckle their seatbelt and get ready for a bumpy ride.
In the meantime, should you attempt to qualify for funding now or in the future, it is important to know the factors that will affect your interest rate. Keep in mind, the number one influencer is environmental, like the state of the economy, which includes the stock market and inflation.
Focus on your internal factors, or “controllables”. These include your debt-to-income ratio and credit score. It’s important to know where you stand in these areas. Given, average interest rates have risen between 6-7%. However, if you’re not within good standing in any of these areas, your interest rate could likely be higher, resulting in much higher debt to manage.
When trying to decide whether it makes sense to take on a loan in our current market conditions, it is helpful to work with a professional to guide you down the right path. VAAS Professionals has over 20 years of experience guiding individuals and businesses down their financial path. We’d be happy to work with you in making the right choice.