Should you be concerned about inflation, as investors and economists are? Certainly not. It could even be a lifeline if you’re paying a mortgage or struggling with student debt.
Prices for everything from old automobiles to timber have been rising as the US economy gradually emerges from COVID lockdowns, with many customers flush with cash from government stimulus handouts. According to a recent study by the National Association for Business Economics, more than 60% of economists say the danger is more significant today than in the previous two decades.
Inflation, commonly measured by the Consumer Price Index, is produced by two factors: consumers have too much discretionary income or not enough products and services to spend it on. These dynamics can produce the same result: Price increases across the board to keep up with demand. Higher prices imply a reduction in purchasing power. Money loses its worth.
So, how does this benefit you?
If you’ve borrowed money for your schooling, a house, or anything else, inflation implies you may be able to repay the loan with dollars that aren’t worth nearly as much as the ones you were given. That could be good news for all types of borrowers, but especially for millennials, who have the highest level of debt of any generation.
There are numerous exclusions. For example, your pay must maintain pace with inflation, and your loan must have a fixed interest rate; otherwise, your interest would likely climb in tandem with other costs, consuming any potential savings. Even yet, for borrowers who match these conditions — and there are sure to be millions of them — inflation may cause interest to disappear mysteriously.
Chris Chen, a financial consultant in Newton, Massachusetts, adds, “It almost seems like a free lunch.”
If you’re looking for a loan with low interest be aware of the fact that GAD Capital is looking for trustworthy customers who can make punctual payments.
How does inflation benefit borrowers?
Assume you make $75,000 per year and have a 30-year fixed mortgage with a monthly payment of about $1,600, which is close to the national median, according to the US Census Bureau. You’re now earning $6,250 (before taxes, for simplicity’s sake), yet your monthly mortgage payments account for around 26% of your income.
Inflation is at about 1.6 percent, which is relatively low by historical standards. Nonetheless, if your pay stays at pace with inflation, you’ll be earning $95,200 in 15 years or roughly $7,900 per month. Your fixed monthly mortgage payment would be reduced to 20% of your take-home salary.
And suppose inflation climbs another percentage point to 2.6 percent, which is still below the long-term historical average of approximately 3%. In that case, your future wage will be a little more than $110,200, or about $9,200 per month, with your mortgage accounting for just about 17% of your income.
When inflation isn’t working
While inflation may be beneficial to people who have a fixed-rate loan, this is not true for those with a floating-rate loan, such as an adjustable-rate mortgage, variable-rate private school loan, or credit card debt. That’s because your interest rate is likely to climb in tandem with any income increases you get if not ahead of.
“Inflationary tides may raise all boats, and not always in a favorable manner,” says Brian Luke, head of Fixed Income Indices at S&P DJI, a financial data firm.
Borrowers’ interest rates on floating-rate loans are usually tied to market interest rates. Lenders are aware of the possibility that their money may be repaid with fewer value dollars in the future. Consequently, the rates they provide are higher than the rate of inflation.
Credit card borrowers, who have some of the highest rates on the market, might be particularly affected by rate changes. That’s because, according to Salt Lake City financial advisor Paul N. Winter, credit card firms tend to raise rates rapidly when inflation worries arise, generally as soon as the Federal Reserve raises short-term rates, but wait and only gradually drop rates when inflation fears pass. Winter explains, “There’s a bit of an unbalanced connection.”
Keep in mind that if your wage does not keep up with growing expenses, inflation may still affect your budget. According to Bureau of Labor Statistics statistics from 2008, when the Great Recession was at its peak, inflation surpassed wage growth by as much as two percentage points. According to PayScale, a pay data business, this is particularly true if you work in an area like education or the food and service industry, where incomes rise at a slower rate.
What to Do If Inflation Is Expected
Refinance: Experts believe that the first step should be to refinance any variable rate debt into a fixed rate if at all feasible. If you have an adjustable-rate mortgage or a private student loan with a variable rate, now is an excellent time to look into refinancing before rates rise. Although this may result in a more outstanding monthly payment since variable rates start lower than fixed rates, Chen believes it will be worth it in the long term if inflation rises.
Pay off credit card debt: If you have credit card debt, now is an excellent time to start paying it off so that your monthly payments don’t take up an increasing portion of your salary, mainly if you work in a field where earnings don’t rise as quickly.
Own stocks if you invest: You want your funds to keep up with growing costs. When you hold bonds, you’re in a similar situation to other lenders in that you risk being paid back with dollars that aren’t as valuable as the ones you lent out. Inflation may wreak havoc on the stock market in the short term, but in the long run, corporate earnings should keep pace with growing prices.