When inflation is high, money loses its value. You need more money to buy the same amount of stuff.

The devaluing of money applies both to savings and debt. If you borrow money, inflation makes the real value of your debt reduce. I’ll say it again, inflation reduces your debt.

It’s a bit of brain teaser, but the concept is quite simple once it clicks.

Because of inflation, the actual dollar amount of your debt doesn’t reduce, but its purchasing power does.

As an example, say you borrowed $60,000 to buy a $100,000 house 20 years ago. At that time you borrowed 60% of the purchase price, $60,000. That was a lot of money back then.

Would you be worried about owing $60,000 on a house today, when the house is worth say $900,000. I’m guessing not.

The dollar amount of your debt didn’t change, but thanks to inflation its purchasing power has dropped away, making the debt insignificant in relation to the value of the asset you own.

How do you get paid to borrow?

Right now inflation is running at close to 7% per annum.

You can get a mortgage for 4.5% per annum.

So your inflation adjusted interest rate is -2.5% pa.

You earn 2.5% per annum by borrowing. On a $500,000 mortgage you earn a real, inflation adjusted return of $12,500 per annum.

Put another way, the purchasing power of your debt shrinks in value by 2.5% per year. Fast forward 10 years. Your property has probably gone up in value and your debt, even without making any payments has gone down, in a real, purchasing power sense.

Let’s compare that with savers. Savers earn 2% pa interest on a term deposit. With the inflation rate at 7% they lose 5% pa inflation adjusted because the amount of their savings goes up by 2% pa, but the cost of everything they want to buy goes up by 7% pa.

In one years time they can buy 5% less of the same goods and services they could a year earlier.

Retirees who’ve worked hard and saved and have those savings in cash or term deposits are made poorer through inflation. Their cash and income aren’t keeping up with the increasing cost of the things they want to buy.

High inflation makes savers losers and borrowers winners. Something to think about.

John Kenel
Assured Property

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