Is Inflation Good Or Bad For My Credit? Theory & practice

The topic of inflation is currently very present in the media. In Germany, the inflation rate will rise to + 4.1% in September 2021. The last time inflation was so high was in December 1993. But does high inflation affect your credit?

Inflation describes the loss in value of money within a year. An inflation rate of currently + 4.1% means that our money is now 4.1% less than in September compared to the previous year.

Example:

You paid a hundred euros for your purchase in September 2020; for exactly the same purchase a year later you have to pay 104.10 euros. Put simply, you can’t buy as much for a hundred euros as you did a year ago.

In nominal terms, you still have 100 euros, but in real terms the 100 euros are worth only 95.90 euros at an inflation rate of 4.1%. In recent years there has been an inflation of around 1.5-2.5%. In order to compensate for the annual decline in purchasing power, wages in most industries rise regularly.

How Does High Inflation Affect Loans?

Basically, in theory, inflation is good for borrowers. When borrowing, the borrower agrees on a fixed interest rate that does not change even with inflation. If the inflation rate is higher than the lending rate, the bank suffers a loss. The money it has lent, including interest payments, is in real terms less valuable at the end of the term than when it was granted. An example:

You are currently taking a 20,000 euro car loan for 5 years at an average interest rate of 2.99% effective (see loan calculator). Currently (as of October 2021) 2/3 of all Postbank customers receive this interest rate. The current inflation rate is 4.1%. The real interest that the bank now receives for your loan is – 1.11%. Due to the loss of purchasing power of the debt, borrowers have to repay less “real” debts, since the 20,000 euro loan will be worth significantly less in real terms in the next few years.

Is it that easy?

In theory, it’s pretty straightforward and simple. In practice it looks a little more complicated. It is assumed that wages and salaries grow on average with the inflation rate. This means that the money has approximately the same value in real terms. Let’s get back to our car loan and assume that the borrower has 2,000 euros net available per month.

The monthly loan installment is currently around 341 euros for the car loan and is fixed for the entire term. If real income were to increase with the inflation rate, the borrower would have more money left at the end of the month in nominal terms (simplified: 2,000 x 1.041 = 2082 euros). This would reduce his monthly load a little. As a rule, however, this only works in theory.

If there are higher inflation rates, incomes usually do not rise at the same pace, so the whole thing only works to a limited extent in the example with consumer loans. BUT: Since all material goods rise in price, the loss in value of a car is nominally not as high as with a low inflation rate.

High Inflation Rate Good For Home Loans?

Yes! There are often much longer fixed interest rates and real estate is a good protection against inflation as material goods. As a borrower, you benefit from fixed loan installments, regardless of inflation. In addition, real estate prices rise above average with higher inflation.

If you rent out the property as an investment, you can adjust the rent annually using an index rent. To do this, one orientates oneself on the consumer price index.

Those: destatis.de