Interest rates

Credit is borrowed money. Many small firms depend on credit such as bank loans and overdrafts to help finance their business activities.

Interest is the reward for lending and the cost of borrowing. The interest rate is the percentage rate charged on a loan or paid on savings. For example, an annual interest rate of 5% means £5 is paid in interest for every £100 saved or borrowed.

Credit rates are often much higher when compared to saving rates

An increase in interest rates can affect a business in two ways:

  • Customers with debts have less income to spend because they are paying more interest to lenders. Sales fall as a result.
  • Firms with overdrafts will have higher costs because they must now pay more interest.

The impact of a change in interest rates varies from business to business. Firms that make luxury goods are hit hardest when interest rates rise. This is because most customers cut back on non-essentials when their incomes fall as a result of interest rate rises.