When real interest rates fall households tend to borrow more. This is because borrowing is cheaper and therefore more attractive when interest rates are low. This can lead to increased spending and economic growth as well as higher levels of debt.
There is evidence that this has been the case in recent years. For example in the UK borrowing by households (including both mortgages and other forms of borrowing) has been increasing since 2013 after real interest rates fell to historic lows (Bank of England 2015). In the US household debt has also been rising in recent years despite interest rates remaining relatively low (Federal Reserve Bank of New York 2016).
There are a number of reasons why households might borrow more when interest rates fall. One is that they may feel more confident about their ability to repay debt when interest rates are low. This is because low interest rates mean that monthly repayments are relatively affordable. This may especially be the case for those with variable rate mortgages who may see their monthly repayments fall if interest rates fall.
Another reason why households may borrow more when rates are low is that they may be anticipating future increases in interest rates. This means that they may seek to lock in low rates now by taking out a fixed-rate mortgage for example. This could lead to increased borrowing in the short-term as households seek to take advantage of low rates before they rise.
Overall then it seems that falling real interest rates can lead to increased borrowing by households. This can have a number of implications for the economy including higher levels of debt and increased economic growth.
References:
Bank of England (2015) Money and credit: latest data. Available at: https://www.bankofengland.co.uk/statistics/money-and-credit/latest-data (Accessed: 16 November 2016).
Federal Reserve Bank of New York (2016) Quarterly Report on Household Debt and Credit. Available at: http://www.newyorkfed.org/householdcredit/2016-q3/data/household-debt-and-credit-report-2016-q3.pdf (Accessed: 16 November 2016).
What happens to household borrowing when real interest rates fall?
Households tend to borrow more when real interest rates fall.
Why do households borrow more when real interest rates fall?
Households borrow more when real interest rates fall because they can finance a larger amount of debt at a lower interest rate.
What is the effect of a fall in real interest rates on household saving?
A fall in real interest rates tends to reduce household saving.
What is the effect of a fall in real interest rates on investment?
A fall in real interest rates tends to increase investment.
What is the effect of a fall in real interest rates on the economy?
A fall in real interest rates tends to stimulate the economy.
What is the effect of a fall in real interest rates on inflation?
A fall in real interest rates may lead to higher inflation in the short run.
What is the effect of a fall in real interest rates on economic growth?
A fall in real interest rates tends to boost economic growth.
What is the effect of a fall in real interest rates on unemployment?
A fall in real interest rates tends to reduce unemployment.
What is the effect of a fall in real interest rates on the stock market?
A fall in real interest rates usually leads to a rise in stock prices.
What is the effect of a fall in real interest rates on the bond market?
A fall in real interest rates usually leads to a rise in bond prices.
What is the effect of a fall in real interest rates on the housing market?
A fall in real interest rates tends to increase house prices.
What is the effect of a fall in real interest rates on interest rates?
A fall in real interest rates tends to reduce interest rates.
What is the effect of a fall in real interest rates on mortgage payments?
A fall in real interest rates usually leads to a reduction in mortgage payments.
What is the effect of a fall in real interest rates on debt?
A fall in real interest rates usually leads to an increase in debt.
What is the effect of a fall in real interest rates on consumers?
A fall in real interest rates usually boosts consumer spending.
