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Are rising interest rates stretching your budget to the limit?
Governments are grappling with the same challenge, as climbing borrowing costs put immense pressure on national budgets. For individuals, businesses, and entire economies, rising interest rates bring financial strain, especially when managing debt becomes a growing challenge.
Here’s a startling fact: the average interest rate on federal debt has more than doubled in recent years. As of October 31, 2024, it stood at 3.30%, a sharp rise from the 1.50% average in 2020. This increase significantly impacts the cost of servicing debt, forcing governments to allocate more resources to interest payments instead of vital programs like education or infrastructure. How does this affect the economy—and what can be done to address the growing debt burden?
In this blog, you’ll explore the impact of rising interest rates on national debt and debt service costs. Let’s explore actionable solutions.
The federal debt-to-GDP ratio has reached unprecedented levels, signaling a critical challenge for fiscal sustainability. As of 2024, the ratio has surged to over 120%, marking one of the highest figures in U.S. history. This growing debt burden stems from years of unchecked borrowing to address economic downturns, fund social programs, and manage crisis-era spending like pandemic relief measures. While these efforts provided short-term relief, they have contributed to long-term fiscal challenges.
What’s even more alarming is the normalization of large annual budget deficits. Historically, deficits were temporary, used to respond to emergencies or stimulate growth during recessions. Today, deficits persist year after year, with projections showing no signs of significant reduction. This entrenched borrowing behavior leaves little room for flexibility, particularly as rising interest rates amplify the cost of servicing debt. Governments are left with fewer options to invest in critical sectors, putting future economic stability at risk.
Between 2020 and 2024, the Federal Reserve implemented significant interest rate hikes to combat rising inflation. The federal funds rate increased from near zero to levels not seen in decades. As of January 2025, the rate was held steady at 4.25% to 4.50%, following rate cuts at three consecutive meetings in 2024's final months.
This monetary policy shift has helped stabilize inflationary pressures but has introduced new challenges for debt management. Higher interest rates translate directly into increased costs for borrowing, significantly affecting the federal budget. Previously, historically low interest rates allowed governments to borrow cheaply, even as debt levels climbed. Now, as rates rise, governments are forced to allocate a growing share of their budgets to interest payments. This trend underscores the broader implications of rate hikes—highlighting the urgency for governments to reassess fiscal priorities and address the mounting cost of servicing national debt.
Debt servicing costs are taking up an increasingly large share of the federal budget, leaving less room for critical public investments. As interest rates climb, governments face difficult choices about how to allocate their limited financial resources. Here's how rising debt servicing costs are reshaping fiscal priorities:
The situation is becoming more dire. According to the Congressional Budget Office, federal interest payments have risen sharply in recent years. By 2033, these payments are projected to exceed defense spending, highlighting the long-term trade-offs associated with unchecked borrowing and rising rates. This shift not only reflects a growing strain on public finances but also underscores the need for policymakers to address these fiscal challenges before they spiral further out of control.
The consequences of high debt servicing costs ripple throughout the economy, creating challenges that extend beyond government budgets. As borrowing costs increase, the following issues arise:
For example, higher government borrowing could lead to increased competition for funds in financial markets, raising borrowing costs for private enterprises. This can discourage entrepreneurs from launching new ventures and slow job creation, ultimately dragging down economic growth.
The debt service coverage ratio (DSCR) serves as a critical metric for assessing a borrower’s ability to meet debt obligations using available income. For governments, the DSCR reflects fiscal health, signaling whether revenues sufficiently cover debt payments. As interest rates rise, maintaining an acceptable DSCR becomes increasingly challenging. With the U.S. federal debt-to-GDP ratio surpassing 120% in 2024, as previously highlighted, the government is facing higher borrowing costs. This is putting additional pressure on the budget, making it harder to maintain a favorable DSCR.
Now, if interest rates rise from 3.5% to 4.75%, the annual debt obligation increases to $546 billion. With the same $600 billion revenue surplus, the DSCR falls to 1.10x ($600B ÷ $546B). This drop below the typical 1.25x threshold represents a heightened financial risk, as revenues no longer provide sufficient cushion to cover debt payments.
Example Calculation:
Let’s consider a property purchase by a government-backed entity for $10 billion with an annual revenue surplus (NOI) of $600 million. The original interest rate was 3.50%, with a 25-year amortization schedule. At a DSCR of 1.25x, the maximum allowable debt service is $480 million ($600M ÷ 1.25). Using these parameters, the loan size would be approximately $7.99 billion.
However, if interest rates rise to 4.75%, the same $480 million in debt service can now only support a loan of $7.02 billion—a reduction of nearly $970 million. This decrease equates to about 10% of the total purchase price, illustrating how rising rates constrain borrowing capacity.
These calculations highlight the domino effect of rising interest rates on debt servicing and fiscal health. Governments must prioritize proactive financial strategies to maintain an adequate DSCR, preserve investor confidence, and mitigate the long-term economic risks of increased debt servicing costs.
Also read: Understanding LTV, DSCR, and Debt Yield in Commercial Loans
Rising interest payments are consuming an increasing share of public funds, surpassing traditional expenditures on education, infrastructure, and scientific research. Policymakers face tough choices, balancing spending cuts and revenue increases to address the fiscal strain.
Addressing these challenges requires bold and forward-thinking leadership. Without policy measures to either cut spending, increase revenues, or both, rising interest payments will continue to overshadow essential services, undermining the government’s ability to invest in its people and future growth. The stakes couldn’t be higher, and inaction will only exacerbate the fiscal strain.
Policymakers and presidential candidates must prioritize discussions on rising federal debt and interest payments. Ignoring these issues could lead to long-term economic instability.
These steps require political will and collaboration, but they are essential to address the challenges posed by rising interest rates.
The ripple effects of unchecked debt servicing costs are undeniable—limited public investments reduced fiscal flexibility, and slower economic growth. Rising interest rates are not just numbers on a chart; they are reshaping priorities and presenting tough choices for policymakers worldwide. Governments must act now to adopt proactive debt management strategies that safeguard fiscal health and future economic stability.
At Shepherd Outsourcing Services, we understand the complexities of managing debt in challenging economic climates. Whether you’re an individual or a business, our tailored debt management solutions are designed to help you regain financial control. Don’t let rising interest rates and mounting debt hold you back. Contact Shepherd Outsourcing Services today to explore how we can help you overcome your financial challenges and build a sustainable future.
Rising interest rates help reduce inflation by discouraging borrowing and spending, which slows down economic activity. However, this also increases the cost of servicing national debt, creating a trade-off for policymakers.
Foreign investors often purchase government bonds, which fund national debt. Rising interest rates can attract more foreign investment due to higher returns but may also increase repayment obligations in the future.
Refinancing becomes more challenging when interest rates are high, as governments may face increased costs to roll over their existing debt. Locking in lower rates during periods of stability is a common strategy.
Rising rates increase borrowing costs for small businesses, making it harder to secure loans for expansion, which can slow job creation and economic growth.
A government default can severely impact its credit rating, increase borrowing costs, and lead to economic instability. It can also reduce investor confidence and limit access to international financial markets.
©2024 by Shepherd Outsourcing.