Inflation may occur at the time you most need it. When this happens, it is clever to take advantage of the situation. Buying a house with a mortgage at a time of low rates is of great financial relief since the mortgage debt decreases in value as time progresses due to the inflation.
On the other hand, deflation can be of the exact adverse influence in your debt. When deflation occurs, your dollar value increases. Deflation is due to the reduced flow of money transactions and small day-to-day financial activities. The increase of money or money substitutes, for instance, credit, is a reason for rising prices, therefore, inflation.
Effectively, an increase in money supply dilutes the money stock that already exists and in this way reduces the burden of debt. To explain further, since the value of old money (the money that was lent) is of less value compared to the money it is being repaid in.
You may ask, how does inflation reduce my debt? Well, this happens in multiple ways.
- Inflation usually keeps pace with your wages but your monthly mortgage payment remains the same.
- Inflation reduces the value of your debt.
Let’s see this now with numbers. For a house that carries a 30 year fixed interest mortgage with an interest rate of 3.25%, the debt becomes easy to pay off in due time. An inflation-induced debt fades off because, at that particular time, you earn more but your mortgage expenditure is still the same. Figuratively, if you initially received an income of $70,000/year, and you are expected to pay a mortgage of $15,000/year, you remain with about $55,000 for normal expenditure. During an inflation period, your income increases slightly above $100,000/year. Here, you commit the usual $15,000 on mortgage and now you have $85,000 for other expenditures and still manage to save the additional $30,000.
We said that inflation reduces the value of your debt but how much? Let’s make some numbers. Let’s assume you buy a house today for $100,000. The average inflation rate is 2.79% (during the last 100 years) so the value of those $100,000 would be just $43,800 in 30 years. Isn’t that amazing?
Inflation, low-interest mortgages and investment properties
Having being enlightened on the great advantage that comes with buying a house with a mortgage, it is wise to make a decision now. But what about buying investment properties?
As we mentioned before, inflation will reduce the monthly payment of your loan and will decrease the value of your debt but now let’s analyse something, even more powerful. The average inflation rate is 2.79% and sometimes we can get a loan for about 3.5% (sometimes even less). What does this mean? Well, it means that we are borrowing money almost for free.
An average rental property in the proper market makes an ROI of 10-12% in cash-flow after paying all the maintenance expenses and the property manager. As I just mentioned, due to the low interest rates and high inflation, we can borrow money almost for free and make 10-12% in cash flow out of it. I think it becomes evident that now, more than ever, we should get a loan and buy rental property. You would be making money every month out of money you got from the bank almost for free and your debt would be destroyed by long-term inflation.