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By Heidi Rivera
May 17, 2021
Everything is floating, except the house is anchored down.
Martín Elfman for Money

Investors and economists are worried about inflation, but should you? Not necessarily. In fact, if you are paying a mortgage or struggling with student debt, it could be a lifeline.

With the U.S. economy gradually emerging from COVID lockdowns, and many consumers flush with cash from government stimulus checks, prices for goods from used cars to lumber have been spiking. A recent survey by the National Association for Business Economics revealed that over 60% of economists believe there’s a higher risk now than any time in the past two decades.

Inflation — usually measured by the Consumer Price Index — is caused by two basic factors: Consumers have too much disposable income or there aren’t enough goods and services for them to spend their money on. Either of these dynamics can have the same effect: A general increase in prices to keep up with demand. Higher prices mean less purchasing power. In other words, money loses its value.

So, how exactly does that help you?

If you’ve borrowed money, for your education, a home or anything else, inflation means you may have the chance to pay back the loan with dollars that are worth a lot less than the ones you were originally lent. That could be welcome news for all kinds of borrowers, but especially for millennials, who have more debt than any other generation.

There are a lot of caveats. For instance, your salary needs to keep up with the pace of inflation, and your loan must have a fixed interest rate, otherwise your interest is likely to rise alongside other prices, eating up any potential savings. Still, for borrowers who do meet these criteria — and there are likely to be millions of them — inflation could mean that interest magically begins to melt away.

“It almost sounds like a free lunch,” says Chris Chen, financial planner in Newton, Massachusetts.

Here’s how it works.

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How inflation helps borrowers

Let’s say you earn $75,000 a year and have a 30-year fixed mortgage with a monthly payment of close to $1,600, which is the national median, according to the U.S. Census Bureau. Right now you’re taking home $6,250 (before taxes for simplicity’s sake), while your monthly mortgage payments eat up about 26% of your income.

The current rate of inflation is about 1.6%, remarkably low by historical standards. Nonetheless, assuming your salary keeps up with the rate of inflation, in 15 years you’ll be earning $95,200, or around $7,900 a month. Your monthly mortgage payment, which remains fixed, would shrink to 20% of your pay.

And if inflation rises an additional percentage point, to 2.6%, which is still below the long-term historical average of about 3%, your future salary jumps to a little over $110,200, or roughly $9,200 a month and your mortgage is only about 17% of your paycheck.

When inflation doesn’t help

While inflation can be good for those with a locked-in rate, the same can’t be said if you have a loan with a floating interest rate, such as an adjustable-rate mortgage, variable-rate private student loan, or credit card debt. That's because your interest rate is likely to rise alongside any salary increases you receive, and maybe even outpace them.

“The inflationary tide can lift all boats, and not necessarily in a good way,” says Brian Luke, head of Fixed Income Indices for S&P DJI, a financial data company.

Rates borrowers pay for floating-rate loans are typically pegged to prevailing market interest rates. Market interest rates tend to rise whenever lenders see inflation on the horizon. Lenders are well aware of the risk the money they hand you today could be paid back years from now with less-valuable dollars. As a result, rates they offer are usually a bit higher than whatever lenders think the rate of inflation will be in the coming years.

Rate shifts can be especially hard for credit card borrowers, who face some of the highest rates on the market. That’s because credit card companies tend to hike rates quickly when inflation fears appear, usually as soon as the Federal Reserve hikes short-term rates — but wait and only gradually lower rates when inflation fears subside, according to Salt Lake City financial planner Paul N. Winter. “There’s a bit of an asymmetric relationship,” Winter says.

And keep in mind, inflation can still hurt your finances if your salary doesn’t keep up with rising prices. For example, in 2008, during the height of the Great Recession, inflation outpaced salary growth by as much as 2 percentage points, according to data by the Bureau of Labor Statistics. This is especially true if you work in a field like education or the food and service industry, where salaries grow at a slower pace, according to PayScale, a compensation data company.

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What to do if you expect inflation

Refinance: Experts agree that the first thing you should do is swap any floating rate debt for a fixed rate, if possible. So, if you have an adjustable-rate mortgage or a private student loan with a variable rate, it may be a good idea to start looking into refinancing now before rates go up. Chen points out that this may result in a higher monthly payment, as variable rates tend to start lower than fixed rates, but it will still be worth it in the long run if inflation does increase.

Pay down debt: If you have credit card debt, now may be a good time to start paying it off to ensure your monthly payments don’t eat up a growing chunk of your paycheck, especially if you happen to be in a line of work where salaries don’t climb as fast.

If you invest, own stocks: You want to make your savings keep pace with rising prices. When you own bonds, you are essentially in the same position as other lenders — facing the possibility of getting paid back with dollars that are less valuable than the ones you loaned out. Inflation can cause short-term disruptions in the stock market, but in the long-term, corporate profits should keep up with rising prices.

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