Disclaimer: Upstart is not a financial advisor. The following content is for informational purposes only.
Simply hearing the word “inflation” is enough to make most people feel nervous. As the cost of living increases and consumers become less optimistic about their finances, it may leave you thinking inflation is a lose-lose situation.
But not everyone loses to inflation.
Inflation does have its downsides. However, it can actually benefit borrowers, lenders, and the economy in certain situations. How so? Let’s take a closer look at inflation’s winners and losers.
What is inflation and how does it work?
To understand who wins when inflation is high, it’s important to first understand what inflation is and how it works.
At its simplest, inflation is an increase in the cost of living. Economists track inflation using two benchmarks: the Consumer Price Index (CPI) and the Personal Consumption Expenditures Index (PCE).
As the indexes rise, the value of the dollar drops, and consumers lose purchasing power. Higher rates of inflation can also result in higher interest rates as the Federal Reserve (aka, the Fed) attempts to control rising costs.
For a deeper dive into inflation, its causes, and its impacts on your finances, you can check out this guide to inflation. In the meantime, let’s take a closer look at inflation’s effect on borrowers and lenders.
Who gains from inflation?
Borrowers with fixed-rate loans
If you’ve got a large, fixed-rate debt, such as a mortgage, auto loan, or personal loan, you may benefit from inflation. That’s because you’ll repay your debt with money that’s worth less than when you took out your loan.
In addition, interest rates on a fixed-rate loan won’t rise or fall with the market. Depending on your loan’s terms and origination date, your interest rate could be substantially lower than current rates affected by inflation.
Put simply, higher inflation rates can make your fixed-rate debts cheaper in the long run.
Stockholders and investors
Inflation often increases market uncertainty. However, some stockholders and investors may avoid inflation’s impact—or even benefit from it.
In some cases, the factors that cause inflation can also increase the value of a company. Higher customer demand for a product or service can drive up costs. Businesses may also increase prices to stay one step ahead of inflation.
Some customers may reduce their spending or consider a cheaper alternative, but others will continue to make purchases. The result? A potentially wider profit margin for businesses and their stockholders.
It’s important to remember that not every industry will see an increased profit margin as inflation rises. For example, retail companies tend to have smaller profit margins. They often experience a loss of profitability during periods of high inflation.
Believe it or not, both debtors and lenders can benefit from inflation. It’s true that existing borrowers—specifically, those with fixed-rate debt—will repay their loans with devalued money. Even so, inflation can drive interest rates up.
When you pay interest on a loan, you essentially rent the money from your lender. If your monthly “rent” increases, your lender’s profit margin could increase, too.
Higher prices often result in less cash flow and increased demand for credit. If more consumers need a loan or line of credit, lenders may get more business.
Who is hurt by inflation?
Retirees living on a fixed income
For many workers, higher inflation means an increase in wages. In fact, U.S. employers plan to increase employee salaries by an average of 3.4% in 2022.
Unfortunately, there’s no raise ahead for retirees living on a fixed income. Rising inflation can also devalue retirees’ hard-earned savings and reduce their spending power. Those with money invested in certain types of stocks and bonds may see their portfolio’s value dip, too.
We already mentioned that existing homeowners with fixed-rate mortgages tend to win in times of inflation. But first-time homebuyers may find themselves on the losing side.
As inflation rises, housing prices may rise with it. Higher inflation rates can make it more difficult to secure an affordable mortgage. You may also find your savings have devalued and you can’t afford the down payment on your home.
Borrowers with adjustable interest rates
If you’ve got variable-rate debt like a home equity line of credit (HELOC), inflation could increase the cost of your debt. That’s because variable-rate loans are usually tied to an external market index or financial benchmark. When the index increases, interest rates—and your monthly payments—often increase along with it.
Banks and lending companies
Banks and lenders can benefit from inflation due to increased interest rates and heightened demand for credit. However, some lenders may lose during periods of high inflation, especially if costs continue to rise for months or years.
As mentioned above, borrowers repay their lending companies with devalued money. Even if every borrower makes their payments on time, their loan provider may still lose money in the long run.
Demand for loans can also slow if the Fed increases interest rates to combat inflation. In this case, consumers are less likely to take out a loan, resulting in less business for lenders.
Preparing for inflation based on your circumstances
It’s not easy to turn periods of high inflation into a win-win situation. Instead, you’re more likely to feel the mixed effects of inflation on your finances.
For instance, you may be making monthly payments on a fixed-rate loan you established 5 or 10 years ago. At the same time, you could be watching the interest on your variable-rate credit card balance climb. Or you may have gotten a well-deserved raise at work—only to see your bills increase each month, too.
However, understanding your financial situation and the potential benefits and drawbacks of inflation can help you prepare for its effects. That may mean finding ways to save on expensive debt, like refinancing an auto loan or consolidating credit card debt. Or it may mean cutting back on spending, budgeting more each month, and taking the first steps to get out of debt for good.
Most importantly, remember that knowledge is power, especially when it comes to inflation. No matter how you take on rising inflation rates, do your research and learn more about the tools you can use to improve your financial health.