What is the relationship between interest rates and borrowing costs?

The correct understanding of the relationship between interest rates and borrowing costs is that higher interest rates increase borrowing costs. When interest rates rise, it becomes more expensive for individuals and businesses to borrow money because the cost of repaying that loan goes up. This is due to the fact that borrowers must pay back not only the principal but also the interest accrued over the life of the loan, which is directly affected by the prevailing interest rates.

For example, if someone takes out a loan at a high-interest rate, their monthly payments will be significantly higher compared to a loan taken out at a lower interest rate. As a result, higher interest rates can lead to reduced borrowing activity because potential borrowers might be discouraged from taking loans that they perceive as unaffordable. Understanding this relationship is crucial, especially in economic contexts, as changes in interest rates can influence overall consumer spending, business investments, and the economic growth of a region or country.