How do interest rates impact borrowing?

Higher interest rates increase the cost of borrowing because they directly affect the amount of interest that borrowers must pay in addition to repaying the principal amount of the loan. When interest rates rise, lenders charge more for the money they lend, meaning that borrowers will end up paying more over the life of the loan. This increase in cost can lead to a decrease in borrowing, as individuals and businesses may be deterred from taking out loans due to the higher overall expenses associated with repayments.

In this context, it's essential to understand how interest rates function as a cost of capital. When rates are elevated, the financial burden on borrowers increases, which can also lead to reduced spending and investment in the economy, as both consumers and businesses may choose to conserve their finances rather than incur additional debt at a higher expense.