The Impact of Rising Interest Rates in 2023: How Will Consumers Be Affected?

In the ever-evolving world of financial markets, the year 2023 has seen a significant shift in the landscape of credit interest rates. This development, while seemingly innocuous to the untrained eye, is poised to have a profound impact on consumers, particularly those situated in the lower income brackets. Economically vulnerable households appear to be most at risk from these fluctuations, threatening the recent strides towards reducing financial inequality in the previous years.

Understanding the Dynamics of Household Finances

Before we delve into analyzing the impending impact of these changes, it's critical to understand the financial backbone of consumer spending. It primarily relies on three pillars: income, savings, and debt. This triad plays a pivotal role in shaping household finances and spending in the present year.

The Role of Debt in Consumer Spending

The third pillar, debt, is expected to assume an increasingly crucial role in consumer spending in 2023. As inflation continues to erode the purchasing power of wages and savings, more and more consumers may find themselves resorting to debt to meet their expenses.

The Rising Cost of Debt

Simultaneously, the cost of debt is anticipated to rise owing to the Federal Reserve's decision to hike interest rates in a bid to curb price growth. To understand these dynamics better, a monthly survey was launched in October 2022 to collect detailed data on income sources and debt flows among U.S. consumers.

The Changing Face of Debt Utilization

An encouraging trend observed in the past months was the decrease in debt utilization pressures for all income groups. This was due to a combination of rising income and lower debt outlays. However, this relief may prove temporary as inflation and rising interest rates continue to shape household finances.

Vulnerability of Lower Earners to Inflation

The lower earners, who were benefited by stronger jobs and wage growth, are disproportionately vulnerable to the negative impacts of inflation. These households rely more on government transfers, including social security, disability payments, and food stamps.

The Domino Effect of Inflation on Debt

The increasing reliance on debt could compound financial strains on U.S. households this year. As these income sources fail to keep pace with inflation, lower earners may be pushed to take on more debt to cover expenses.

The Debt Distribution Breakdown

The largest monthly debt obligations reported by consumers are housing costs and credit card debt. The type of housing-related debt, however, differs significantly across income groups. High earners are much more likely to have a mortgage, implying homeownership. In contrast, lower earners' housing debt is tied more to rental leases, leaving them with less potential for future financial recoupment.

Debt Tied to Consumption Vs. Investment

Lower earners' debt is primarily tied to consumption, which includes credit purchases, "buy now, pay later" programs, medical debt, and rents. In contrast, higher earners have a larger share of their monthly debt tied to assets or investments with potential future value, such as mortgages, education debt, or auto loans.

The Threat of Inflation and Rising Interest Rates

The consumption-related debt, which constitutes the majority of lower-income consumers' monthly outflows, leaves its holders more exposed to inflation. As everyday expenses climb, so too could debt, even as the cost of carrying it increases due to higher interest rates.

Rising Risks in the Income Spectrum

With the labor market expected to cool down and layoffs concentrated among high-paying sectors, households earning $100,000 or more annually could be detrimentally impacted. Consequently, risks are mounting at both ends of the income spectrum.

The Profits and Pitfalls of the Credit Card Industry

The credit card industry remains profitable despite the changing dynamics. However, the rise of point-of-sale, Buy Now, Pay Later (BNPL), fintech personal loans, and "pay-by-bank" options have increased competition with traditional credit cards for purchase volume and balances.

The Cost of Credit

The cost of credit has reached an all-time high, with issuers charging more than $130 billion in interest and fees in 2022 alone. The total cost of credit by the end of 2022 was nearly 18 percent on general-purpose cards and over 21 percent on private label accounts.

The Rewards and Risks of Credit Card Use

The rewards earned by general-purpose cardholders exceeded $40 billion for mass-market issuers in 2022. However, when a consumer revolves a balance on their credit card, the cost of interest and fees almost always exceeds the value of rewards the consumer may have earned.

The Advent of New Features and Products

As the market continues to evolve, new features and products have emerged. Installment plan features, which allow cardholders to convert a credit card purchase to a lower-cost, fixed-rate loan, comprise a small but growing segment of the market.

The Challenge of Persistent Debt

With the average minimum payment due increasing to over $100 on revolving general-purpose accounts in 2022, more users are incurring late fees and facing higher costs on growing debt.

The Availability and Application of Credit

Most measures of credit card availability grew in 2021 and 2022 after a sharp decrease in access during 2020. Application volume for general-purpose credit cards reached a new peak in 2022, as issuers increased acquisition efforts and consumer demand grew.

The Future of Credit Interest Rates and Their Impact

As we move forward, it's clear that the rising credit interest rates are set to reshape the financial landscape for consumers, particularly those in the lower income brackets. While these changes may initially seem abstract and distant, they hold tangible and potentially devastating implications for many households.

The Role of Financial Institutions

As such, it's incumbent upon financial institutions to not only monitor these developments closely but also to take proactive measures to mitigate their impacts. This could involve exploring ways to promote comparison shopping on purchase APRs—a major cost of credit cards that is often unknown to consumers prior to card issuance.

Ensuring Adequate Consumer Protection

In an era of increasing financial uncertainty, ensuring adequate consumer protection is more critical than ever. This involves not only monitoring assessments of late fees, reliance upon penalty repricing, and debt collection practices but also ensuring the disclosure of minimum payments in accordance with CARD Act requirements.

Conclusion

The year 2023 is shaping up to be a turning point in the realm of credit interest rates and their impact on consumers. As we navigate the shifting sands of this financial landscape, it's essential to remain vigilant and proactive, ensuring that all consumers, especially those in the lower income brackets, are equipped to weather these changes.