Price inflation is on the uptrend in Australia. As a result, interest rates are going up and the cost of servicing a mortgage loan increases as well. But some people claim that price inflation is good news for the borrower. The logic behind such a claim is that the real value of the debt decreases due to price inflation. Conversely, deflation benefits the lender because the real value of the loan increases due to price deflation.
Is this always true? Of course not!
In what circumstances will price inflation benefit the borrower? When will it be detrimental? To make life easier for you, we will provide you with a highly simplified rule-of-thumb formula that will help you to understand whether price inflation will harm or benefit you as a borrower:
Debt servicing burden = (Debt payment rate – Growth in wage) + Price inflation rate
As you can see, price inflation alone does not reduce your debt burden. Your wage has to grow along with price inflation. But that is assuming that the debt payment rate (e.g. mortgage rate) does not increase.
The worst-case scenario is when your debt payment rate increase along with price inflation, while your wage remains stagnant-in such a situation, you find your mortgage payment and life expenses increasing while your wage remains constant. For Australia, this is the current situation. Mortgage and interest rates are rising, price inflation is increasing, but wages have yet to catch up. No wonder borrowers are finding life harder!
