Blog posted On June 22, 2021
With the Federal Reserve deciding to leave interest rates unchanged, inflation will likely continue to heat up. Though this is generally a good sign of an improving economy, it tends to have negative effects like higher prices and lower purchasing power. For consumers, this isn’t ideal. But for borrowers, it can actually help them save on interest and pay off their debts faster.
What are the benefits of inflation?
When prices rise, money loses its value and consumers lose their purchasing power. Borrowers, on the other hand, gain power. With money at a lower value than when you took out a loan, you’re essentially paying off your debt at a lower cost. This can be extremely beneficial for a variety of borrowers with high interest debt like student loans or mortgages.
Who does inflation help?
Though inflation can help certain borrowers, it doesn’t help everyone. Before you get excited about rising prices, ask yourself:
Not all salaries can keep up with the pace of inflation. For example, if you work in education or the food and service industry, your salary grows at a slower pace, and might not be able to keep up with a sharp spike in inflation. In 2008, inflation outpaced salary growth by as much as two percentage points – leaving millions of Americans struggling to maintain their cost of living. However, if your salary does keep up with the pace of inflation, it could help you. Let’s say you’re taking home $6,250 per month (pre-taxes) from your annual salary ($75,000) while paying a $1,600 per month on a 30-year fixed rate mortgage. In this scenario, your mortgage payments would be taking up 26% of your income. If inflation is increasing at a 3.1% pace, which was the April 2021 reading of the core personal consumption expenditures (PCE) price index, then in 15 years, your $75,000 salary will be around $119,000. At that point, you’d be taking home $9,917 per month and your monthly mortgage payments would only take up 16% of your income.
The key is having a fixed-rate loan. If you have an adjustable-rate mortgage (ARM) or other type of floating rate loan, you likely won’t benefit from inflation even if your salary increases. Fixed-rate loans won’t change with the tides of inflation. If inflation is at 3.1%, your interest rate and mortgage payments will still stay the same as they were when you closed on your loan. With an ARM, your interest rates ebb and flow with the market conditions. So, if inflation causes a spike in prices, your interest rate can spike as well. This can take an especially costly toll on credit card borrowers, whose interest rates are already so high, because they will rise quickly when inflation heats up.
How to handle inflation
If you know an inflation spike is on the horizon, there are a few different ways you can prepare.
Higher interest rates are likely coming soon, so if you need to explore your refinancing options, now is the time. Whether you’re looking for a little extra cash to help pay down other debt or you just want or switch to a fixed-rate mortgage while rates are low, we would be happy to help you with a home financing solution.
Sources: Bureau of Economic Analysis, Money, Smart Asset