What increases the cost of debt?
Naturally, rising interest rates will make borrowing more expensive across the board. Over the past year-plus, the Federal Reserve has raised the overnight federal funds rate at its fastest pace in history, leading to substantially higher borrowing costs for almost all forms of debt. In other words, loan origination (and the forthcoming interest expense) just got much more expensive, especially because interest compounds exponentially.
As companies add new debt to their balance sheets, their average cost of debt increases; in dollar terms, they'll see a higher interest expense on their income statement. Further, if the company has debts with long payback periods (or longer terms), it will pay more to borrow over time than if it had taken a shorter loan with higher periodic payments.
These are all decisions a company has to make when considering its entire financial picture, but primarily with regard to its ability to service its obligations on a consistent basis. Higher rates, unfortunately, typically mean a greater reluctance to invest in new projects since the cost of failure is so much higher.
Think about how the cost of debt might rear its head in everyday life. A family that buys a new home with a large mortgage in 2023 will pay substantially more than if the family bought the same house at the same price in 2020. The family's cost of debt is undeniably higher than it would have been had they acted when interest rates were lower -- but of course, there are other considerations that would make a family buy a home beyond just their cost of borrowing.
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