6 Ways High Interest Rates Cost Poor People the Most
If you’re saving money, rising interest rates are a gift from the heavens — or at least from the Fed. If you’re borrowing money, they’re a burden you tolerate until rates fall and you can refinance.
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But if you’re poor, even slightly higher interest rates can mean the difference between struggling to get by and falling off a financial cliff. That’s because many opportunities for healthy borrowing are off-limits to low-income households, which often leaves toxic borrowing as the only means of survival.
Let’s dig into some ways poor folks are most impacted by rising interest rates:
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The Poor Use Debt To Manage Emergencies
People in good financial health have emergency funds they can tap when unforeseen expenses sneak up. But those without a savings cushion must borrow their way out of expensive emergencies. Toxic borrowing is often the only option and high interest rates always increase the toxicity.
“I have seen many cases where a single medical emergency or temporary loss of income led to high-interest debt that haunted the individual for years,” said David Fritch, founder of the Fritch Law Office, where he’s spent 40 years helping people manage debt issues. “Because those with lower incomes have little savings to fall back on, they often turn to credit cards, payday loans or other predatory options to make ends meet. The interest rates on these products, sometimes over 500% APR, make the debt balloon quickly, even when payments are made.”
High-Interest Borrowing Leads to More High-Interest Borrowing
Low-income individuals are especially vulnerable to the vicious cycle of borrowing to cover yesterday’s borrowing, and the consequences can follow them for life.
“When interest charges accumulate faster than one’s ability to pay them off, it creates a cycle of debt that is nearly impossible to escape,” Fritch said. “There are few good options in these situations. Non-profit credit counseling, debt management plans and bankruptcy are often the only ways out. But the damage to credit scores and financial stability has already been done. Capped interest rates, restrictions on predatory lending and financial education are some of the only real ways to help prevent these devastating cycles of debt.”
Each New Rate Hike Further Squeezes Already Tight Budgets
When rising rates make debt more expensive, financially stable households divert funds to cover the cost by reducing their investment contributions, pausing their charitable giving, etc.
Those living on the financial edge rarely have those options. They face far more daunting choices.
“High interest rates disproportionately hurt the poor because they have little room for error in their budgets,” said Nischay Rawal, certified public accountant and owner of NR Tax & Consulting. “When interest rates rise, minimum payments on debts also rise. For those with little disposable income, even a small increase can mean defaulting on payments or sacrificing essentials like food or medication.”
Higher Rates Make Minimum-Only Payments More Likely and More Difficult
If low-income households making only the minimum payments gain enough traction to pay a little more each month and start digging out, a single rate hike can put them right back where they started or worse.
“Our firm works with many clients struggling under massive credit card debt and high-interest personal loans,” Rawal said. “For one client, a 2% rate hike on their credit card raised their minimum payment by over $50 monthly. On their limited income, this increase forced them to cut their grocery budget, creating a cycle of relying on expensive predatory lenders to afford basic necessities.”
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Rising Rates Are Roadblocks on the Path to Improvement
People struggling with low incomes can improve their situation through moves like buying a vehicle to get to work or pursuing a degree to earn a better salary — but those purchases require financing, which rising interest rates can put out of reach.
“When interest rates rise, those who rely on loans to buy a car or pay for education face higher monthly payments,” said Paul W. Carlson, managing partner of Law Firm Velocity, a team of financial attorneys. “For someone living paycheck to paycheck, even a small increase in interest rates can make it difficult to afford these necessary expenses.”
When Debt Consumes Every Spare Dollar, None Are Left To Build a Future
Thanks to compounding, struggling households can slowly build financial security over time by dedicating even a few dollars per month to saving and investing. But when interest rates rise, their debt gets more expensive and gobbles up those crucial few extra dollars.
“Even if poor people are trying hard to save and invest, an increase in interest rates means they cannot afford to invest in assets like real estate or stocks,” Carlson said. “Many low-income individuals may be saving for emergencies or future expenses, but if they’re unable to invest in appreciating assets, their savings lose value over time due to inflation. As a result, the financial burden falls disproportionately on the poor, who often have less flexible budgets. For example, someone earning minimum wage might find their purchasing power decreases as prices rise, making it harder to afford basic necessities. Meanwhile, wealthier individuals will benefit from high interest rates because they can invest in assets that typically outpace inflation, further widening the gap between the rich and the poor.”
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This article originally appeared on GOBankingRates.com: 6 Ways High Interest Rates Cost Poor People the Most