How the Economy Affects Loans

Economic growth depends on consumers spending money. However, they may only be willing to pay if they’re worried about their job security or the economy. That’s why it’s essential to understand how the economy affects loans.

Resuming loan payments could cool the economy as people divert spending toward their debts. However, the impact should be relatively small for most borrowers.

Interest rates

Interest rates are a crucial driver in the economy, and they impact loans as well as savings. The Federal Reserve sets what is known as the “federal funds rate,” which determines how much banks can charge each other for quick, overnight loans to meet their legal reserve requirements. This benchmark influences all consumer loan products, from credit card interest rates to home mortgages and private student loans. The Fed usually raises interest rates during good economic times and lowers them during recessions.

When rates rise, purchasing goods and services become more expensive for consumers and businesses. This slows the economy down.

It also makes it more difficult for savers to earn interest on their money and could prompt companies to put any expansion plans on hold. With 40 million Americans still paying off student debt, higher rates could also push those payments up.

Inflation

Inflation increases prices, meaning borrowers have less money to pay off their debts (assuming their wages have stayed the same). This can lead to higher default rates on loans. However, if a lender raises interest rates to combat inflation, it can cool demand and reduce loan defaults.

Inflated prices can also lead to shortages. For example, the COVID-19 pandemic caused many consumers to overbuy products like toilet paper and hand sanitizer, reducing supplies and increasing prices. This is called supply-side inflation.

Inflation also makes money lose value over time. This benefits borrowers with fixed-rate loans, as it reduces their actual interest rate. It’s also beneficial for lenders, who can increase their loan demand and adjust the variable interest rates on existing credit products. The fluctuating mortgage rates in Denver and other desirable cities makes this extra profitable for banks, as homes in 2023 are often overvalued. This can make buying a home or starting a new business more expensive, but there are financing alternatives to consider than conventional loans, like revenue-based lending.

Disposable income

Disposable income is a key economic indicator for both households and countries. Economists use it to determine consumer spending and savings rates. It is also one of the five determinants of demand. The higher the disposable income, the more consumers are likely to spend and save.

A person’s disposable income is the amount left over from their paycheck after all mandatory deductions have been taken out, including federal, state, and local taxes, social security contributions, wage garnishments, back wages, court-ordered child support, and tax refunds. This figure does not include indirect taxes, such as value-added and sales taxes.

This money is then compared to a person’s necessities, such as housing (rent or mortgage), utilities, food, and transportation. The remainder is the money they can spend on “wants,” such as entertainment and travel. In the United States, this number is reported by the Bureau of Economic Analysis. Economists also use it to compare economies around the world.

Fixed expenses

A fixed expense is a regular bill or cost that stays the same each month. These include your mortgage, rent, car, insurance, utilities, and loan payments. This expense is often compared to variable costs like clothing, dining out, and entertainment. A reasonable budget should balance both types of costs.

When you have a clear idea of your fixed expenses, it is easy to determine how much you can spend on discretionary items. It also makes it easier to save money for future expenses. You can list all your monthly fixed expenses by tallying up your take-home income and subtracting it from your total spending.

The Supreme Court’s ruling striking down Biden’s student loan forgiveness program could cool the economy by reducing disposable consumer spending by as much as $70 billion annually. This would be a small percentage of the overall economy and is unlikely to cause lasting damage.