Many countries across the globe became victims of high inflation, especially during the onset of the pandemic. This meant that the price of goods and services increased, and there was a fall in purchasing power.
With everything likely to be negatively affected by high inflation, should an individual take out a loan during this period?
Read on to find out.
Content Summary
What Is High Inflation?
High inflation is a situation where there is an increase in the price of goods and services and a decrease in purchasing power.
Purchasing power is the value of a country’s currency. This value is determined by how many goods and services a currency unit can buy.
Several factors can cause high inflation, such as national debt. When a particular country has overwhelming debt, the government may be forced to increase taxes. If they do so, businesses will automatically shift that burden to consumers by increasing the price of goods and services.
Another major factor likely to cause high inflation is the government’s rules and regulations.
The government may impose rules and regulations that make it difficult and expensive for various businesses to produce goods and services or even import them. As a result, companies may push this burden onto consumers by increasing the price of their goods and services.
An increase in money circulation or supply may also cause high inflation. When more money is circulating between people than what is being produced, there may be inflation. Since there will be a high demand for goods and services, businesses may increase the prices of their commodities.
Should You Take Out a Loan When Inflation is High?
Well, yes and no. There are advantages and downsides to taking a loan during high inflation. So, what are the benefits of taking out a loan when inflation is high?
If a borrower takes out a loan with fixed interest rates, they are likely to pay back less money than they borrowed. Since the interest rates are fixed, high inflation cannot affect them. So, borrowers will pay back the same interest set initially but with money whose worth is less than the funds they initially borrowed.
Another way fixed interest rates loan borrowers may benefit from high inflation is that the financial burden of paying back the loan may decrease.
High inflation may increase people’s wages and salaries. So, when inflation is high, a borrower’s income may increase, but their loan’s monthly payments and interest rates will remain constant. Therefore, the financial burden of paying back the loan may decrease.
What Are the Risks of Taking Out a Loan During High Inflation?
The main disadvantage of taking out a loan when inflation is high is that the overall cost of the loan may be high.
Lenders may increase the cost of loans, that is, the interest rates and additional charges such as application fees. They do so to compensate for the loss they will incur when other borrowers repay their debts. Remember, when inflation is high, individuals are more likely to pay less money than they borrowed.
Most of the disadvantages of taking out a loan during high inflation apply to loans with variable rates, such as interest-free loans.
Interest-free loans begin attracting interest fees if the borrower doesn’t pay back their loan within the agreed repayment period. Since these interest rates are not fixed, the lender may increase them to compensate for the decrease in the currency’s value.
The same thing applies to other types of loans like mortgages and credit cards that don’t have fixed interest rates.
As mentioned earlier, high inflation may cause an increase in the price of goods and services. This may result in high demand for loans, leading to lenders increasing the interest rates for their loans.
Conclusion
High inflation is a global issue that affects many areas of people’s lives. When it comes to taking out a loan during this period, individuals need to consider several factors before applying for a loan.
When taking a loan when inflation is high, the main factor to consider is whether the borrower will use the loan on something with long-term value.
If an individual cannot repay the loan, especially if it has variable interest rates, they can sell that property and pay back the loan.
