6 Things That Happen When Interest Rates Rise

When interest rates rise, borrowing generally becomes more expensive. Savers, meanwhile, can benefit from higher yields on deposit accounts and newly issued fixed-income investments. Higher rates can also affect consumer spending, housing affordability and investment values.

Working with a financial advisor can help you prepare a proper financial plan and course of action.

What Happens When Interest Rates Rise

Rising interest rates impact your finances in many ways. Some are positive, while others are negative. The effect can depend on whether you are borrowing, saving, investing or preparing to make a large purchase.

Here are the six things that typically happen whenever interest rates rise:

1. The Cost of Borrowing Money Increases

As interest rates increase, it becomes more expensive to borrow money. Interest rates are one of the three major factors that determine your monthly payment. The others are the amount borrowed and the time to repay the debt.

Borrowers with variable interest rate debt are affected immediately as rates increase. Existing fixed-rate loans are not affected, but payments for new debt can go up considerably.

For example, if you want to borrow $300,000 for 30 years, the payment can increase significantly with rising interest rates. At 2% interest, your monthly payment is $1,108.86. However, if rates increase to 4%, the payment increases to $1,432.25 per month. That is almost 30% higher.

2. Consumer Demand Decreases

When it costs more to borrow, consumers can reduce spending, particularly on purchases that rely on financing. Higher rates can also increase payments on variable-rate debt, leaving some households with less money for other expenses. Reduced demand is one channel through which tighter monetary policy can slow economic activity and ease inflationary pressure.

3. Savers Earn More Interest

People who have money in savings accounts, money market accounts and CDs can benefit when financial institutions raise deposit rates. However, banks do not have to increase savings rates by the same amount or at the same time as changes in Federal Reserve policy.

Existing fixed-rate CDs generally keep the same rate until maturity. New CDs can offer higher yields when market interest rates rise, although rates vary by institution, term and market conditions.

4. Stocks Become Less Attractive

Wooden blocks indicating the change in interest rates.

Higher interest rates can put downward pressure on stock valuations, but stocks do not necessarily fall whenever rates rise. Higher yields can make bonds and other fixed-income investments more competitive with stocks. Rising rates can also increase companies’ borrowing costs and increase the discount rate that investors apply to expected future earnings.

The effect varies across companies and sectors, and stock prices are also influenced by economic growth, corporate earnings, inflation expectations and investor sentiment. Federal Reserve research shows that monetary policy can affect equity prices through several channels, including changes in yields and the returns investors require for taking equity risk.

5. Bond Values Drop

Higher interest rates generally reduce the market value of existing bonds. When newly issued bonds offer higher yields, existing bonds paying lower rates become less attractive unless their market prices decline. Bond prices and interest rates generally move in opposite directions.

If you own an individual bond and hold it to maturity, normal market price fluctuations do not change the principal amount the issuer is obligated to repay, assuming the issuer does not default. Selling before maturity, however, can produce a gain or loss.

Bond funds work differently because they hold portfolios of securities with varying maturities and continuously changing market values. Their share prices can decline when rates rise, although over time, the fund can also reinvest in bonds offering higher yields.

6. Buying a Home Is More Expensive

Household budgets and underwriting limits place a cap on how much many buyers can afford to spend each month for their mortgages. Prospective homebuyers can have a harder time affording the same loan amount as rates increase because higher mortgage rates increase monthly principal and interest payments.

Buyers may respond by purchasing a less expensive home, making a larger down payment or postponing a purchase. Home prices do not automatically decline when interest rates rise because inventory, employment, household formation and local supply and demand also affect housing values.

How Rising Rates Affect Different Types of Debt

The impact of higher interest rates depends heavily on the type of debt you already carry. A fixed-rate mortgage, auto loan or personal loan generally keeps the same interest rate and scheduled payment after market rates rise. The higher-rate environment becomes relevant when you take out a new loan or refinance an existing one.

Variable-rate debt can react more directly. Credit cards commonly carry variable annual percentage rates (APRs), while adjustable-rate mortgages and some other loans can reset according to a benchmark specified in the loan agreement. When the applicable benchmark rises, the interest charged on these debts can increase, subject to the account’s terms and any rate caps.

This distinction can help when reviewing debt during a period of rising rates. Knowing which balances have fixed rates and which can reset shows where higher market rates could affect your monthly costs.

How to Benefit From Rising Interest Rates

While rising interest rates can negatively affect some areas of your finances, higher rates can also create opportunities for savers and fixed-income investors. Strategies to consider include:

Review variable-rate debt. Paying down high-interest variable-rate balances can reduce your exposure to future rate increases. Refinancing into fixed-rate debt could also provide more predictable payments. Just make sure to consider both the fees and the new rate before refinancing.
Compare savings yields. Higher-rate environments can create opportunities to earn more on savings accounts, money market deposit accounts, CDs and other cash holdings. Comparing annual percentage yields (APYs) can help identify whether your current account remains competitive.
Evaluate fixed-income investments. New bonds can offer higher yields after rates increase. Investors should still consider maturity, duration, credit quality and liquidity rather than choosing an investment based on yield alone.
Keep long-term investments in perspective. Interest-rate changes alone do not determine stock market performance. Investment decisions should account for your time horizon, risk tolerance and overall asset allocation rather than short-term rate movements.

Ultimately, you may want to discuss how interest rates could impact your investments with a proven financial advisor who can help you manage your portfolio.

Bottom Line

An advisor reviewing interest rate changes.

If you’re wondering what happens when interest rates rise, the answer depends on which area of your finances you’re looking at. Rising interest rates can increase the cost of new borrowing and variable-rate debt while allowing savers to earn higher yields on some accounts. Existing bond prices generally decline when market rates rise, while the effect on stocks and real estate is less predictable. Reviewing the rates on your debt, cash accounts and investments can show where a changing interest-rate environment has the greatest effect on your finances.

Tips for Dealing With Inflation

A strong financial plan can help you prepare for inflation or an economic drop. Having a financial advisor in your corner can help you ensure you’re prepared for all situations. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Inflation is a silent killer for retirement portfolios. If your retirement income doesn’t keep up with rising costs, your purchasing power will decrease over time. Our inflation calculator forecasts the rising cost of items over time due to inflation.