How does interest rate affect business and Economy

How do Interest rate affect Business and Individuals?

The interest rate that an individual or a company pays for a loan depends largely on the credit worthiness of the person or organization. However, the rates offered by the lenders, on the whole are shaped largely by larger economic forces that affect supply and demand for money. A change in the average interest rate generally affects businesses and individuals in many ways.

Interest rate influence Economic changes:

The change in interest rate has a direct effect on the economy. Generally, the lower interest rates encourage companies to the expansion. This is due to the fact that the companies are able to borrow money at a lower interest rates. This provides an opportunity to borrow money necessary to expand the business. This also results in recruiting more employees, which can further stimulate the economy. However, interest rates, too low can cause the economy to overheat and fall.

Role of Interest rate in Consumer spending

Changes in interest rates boost consumer spending up and down in two ways in an economy.

  1. First, when a change in the interest rate expands or collapses the economy, the rate of employment changes. For example, when more people have jobs, as is the case during an expansion, people tend to spend more money.
  2. Second, when interest rates are lower, people spend more money because they can borrow money more cheaply. When interest rates are higher, people spend less.

More Commercial Loans when Interest rates are low

Companies may consider expanding when interest rates are low, as they are able to obtain business loans at a lower interest rate. For a company, a period of low interest rates may signal a time in which the company should choose to relocate to another market, to acquire a large customer base or launch a new product. However, low interest rates do not always mean that loans are easier to get, only that they are, on the whole, cheaper.

Interest rate influence Mortgages:

Purchasing house is a type of consumer spending which is directly influenced by the interest rate. Because, majority of the people take up loan to buy a new home. When interest rate are more attractive, most people take out a loan to buy a home, but when interest rates rise, fewer people buy homes, because it costs more money to pay back. Therefore, the change in interest rate can directly influence mortgages.