If you are paying a fixed rate on a mortgage, is inflation then a good thing?
In: Economics
I teach AP Econ to non-native speakers, so if I can’t do this ELI5, I should probably be fired.
Yes, inflation is good for your mortgage. Imagine your monthly payment is $1,000 and your monthly salary is $5,000. That means, every month, you’re paying 20% of your annual salary toward your mortgage.
But over time, the value of each dollar is cut by half and both prices and salaries double as a result of inflation (e.g. your monthly salary goes from $5,000 to $10,000, but still buys the same amount of stuff as before because everything got twice as expensive). However, the “price” of your mortgage hasn’t changed – it’s still $1,000/month. You used to pay 20% of your salary toward your mortgage, and you’re now only paying 10%, so your mortgage has effectively gotten cheaper.
This is a gross simplification that doesn’t consider all the other effects of inflation, but purely in terms of your fixed rate mortgage, yes, inflation is good. In general, we say that when loans are fixed rate, borrowers benefit from unexpected inflation and lenders are harmed. This is why lenders like adjustable rate mortgages – it mostly eliminates their risk due to possible future inflation.
Yes. Definitely a hedge against inflation or price increases in the housing market. My mortgage plus taxes is still much cheaper than a rent for equivalent space.
Yes. The value of your mortgage is set in nominal terms the day it is originated. Assuming it’s a conventional fixed rate mortgage, you have the benefit of repaying the note with inflated dollars.
Yes. It creates equity without risk…which is generally considered fraud in accounting but not here. Enjoy the $$
Yes and no. It’s better to pay off debt with inflated money than constant or depreciated money. That’s why there is interest, it’s the cost for present vs future money, inflation has already been baked into the cost of the loan.
The problem is when income doesn’t keep pace with inflation. When disposable income decreases due to inflationary pressure on other purchases like utilities, gas, groceries, or other inflexible goods, then the mortgage becomes more difficult because of the collateral effects of inflation, even though the mortgage payment is constant for the life of the loan.
For the mortgage specifically, and if you have a fixed rate mortgage, yes. For everything else, no.
When I purchased my house it was valued at $225k. I put down $25k and mortgaged the rest. So for the next 30 years, I’m paying off that $200k based off the payment schedule the bank created when they issued me the loan. That never changes assuming I don’t refinance.
My property tax and insurance are NOT subject to those same terms. As housing prices went up, so did my taxes and insurance. I’m now paying roughly an extra $500 a month than I did 3 years ago when I bought.
So I’m in a better spot than if I bought today, hell I wouldn’t be able to afford the house I’m in if I tried to buy today, but I’m not ENTIRELY protected from inflation related expenses.
Inflation is good for all debt. Mortgages are just one form. So is government debt.
This is why inflation is good for the economy in small doses: it encourages you to spend more money now since that same thing will cost more in the future if you wait. But if you buy it with debt, that debt amount is fixed so over time it’s less. This encourages people and companies to spend more money now instead of waiting and “rewards” them for doing it.
Short answer, no. Long answer is that while your effective mortgage rate will decrease, your income will likely increase at a slower rate so on the whole you’ll end up behind when inflation spikes. If it holds steady, then in the long run you’re effectively paying less, but that’s one of the main reasons loan companies have you pay so much interest up front
Yes. It erodes the value of the loan principle over time. Inflation is always good for debtors in that way.
This is actually why the USA still had silver-backed money for a while in the late 20th century. Farmers teamed up with silver miners to lobby the government. They got Congress to pass a law forcing the government to buy silver and issue dollars backed by it. The miners wanted this because they wanted guaranteed customers for their product. But the farmers wanted it because it would induce inflation. So while the prices of their crops would rise, the value of their loans would fall.
I bought in 1983 at the bottom of the recession where inflation was 8-10% and a 1 year mortgage was 15%.
5 years later with inflation my wage had increased 40%, so my perceived debt owing on the house had reduced by 40%. The first few years where 17 dollars per month came off the principal and the rest 750 dollars was interest were not fun as I had the feeling of treading water in the deep ocean.
Lots of people got upside down on their homes as property values crashed with high interest rates as they owed more money than their homes were worth on the market. Smart people held on and people that went under ended up with debt after selling their homes.
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