How to Manage Loan Repayment During Inflation

What is Inflation?

It is the decrease in purchasing power while the cost of goods and services increases. We experience inflation with increasing costs over a period of time.

Living a comfortable life requires a diverse range of products and services. But, with inflation, the cost of these essentials keeps rising and decreases economic growth.

So, it is crucial to understand how inflation affects our day-to-day lives, especially if you have a loan in the mix.

How Does Inflation Affect Loans?

Interest Rates

The RBI tends to raise rates of interest to control inflation. Suppose you have a floating interest rate/variable interest rate loan. In that case, your monthly instalments will increase as a result of inflation.

Demand for Loans

When inflation is high, people borrow money to meet big-ticket expenses. This leads to higher interest rates and stringent lending practices.

How can you combat the rising interest rates if you are a new borrower? Or how can you use inflation to your advantage if you’re an existing borrower?

A Guide to Beating Inflation Effects on Loans

1. Increase Tenure

To ease the effect of inflation, you can opt to increase the loan repayment tenure. This will keep your monthly expenses in check. However, you must carefully plan this strategy to ensure you don’t continue paying for a long time even after inflation has reduced.

2. Partial Repayments

If you are able to, choose to repay a big part of the loan amount in one go as a partial repayment. This will help reduce the monthly instalment amount or the tenure of the remaining loan amount, easing your financial woes.

3. Fixed-rate Loans

When your loan’s rate of interest remains constant, you are protected from rising interest rates resulting from inflation. Check if your lending institution has the option to refinance your variable interest rate loan to a fixed one.

4. Diversify Borrowing

Explore alternative lending sources if you are borrowing during inflation. Credit unions and online lending apps nowadays offer competitive terms.

5. Cut Down on Expenses

Be frugal and cut down on unnecessary expenses. The money you save can be used for loan repayment or placed in an emergency fund.

6. Consider a Side Hustle

Use your skills or creative side to explore freelancing or consulting and increase your income. Any additional income can be used for loan repayment and ease inflation effects.

Inflation Effects on Borrowers and Lenders

Borrowers: If your monthly salary increases with rising inflation, you can quickly pay off your debt. Since your monthly loan instalments remain the same, you can use your increased salary for other expenses.

Borrowing a new loan during high inflation can also be a disadvantage if you choose a longer repayment period. During inflation, the interest rate will be high. And subsequently, your monthly instalment will be higher. If your repayment period is also high, you will need to repay this loan at a high interest rate and for a longer time, even after inflation has slowed down.

Lenders: Inflation can adversely affect lenders. The money they get back has lesser purchasing power than the money they originally gave out as loans. From a bird’s eye view, inflation benefits existing borrowers more than lenders.

The scenario flips when lenders lend to new borrowers. With the demand for credit at a high interest rate and longer repayment tenure, lenders benefit long after the effects of inflation ease.

In Conclusion

Managing financial commitments during inflation requires careful planning. You must plan your expenses to have a little cushion to absorb price hikes. This cushion can also help your loan repayment.

You must consider the options available from your bank or credit union during this period of inflation.

If the strain of inflation is high, consider extending your loan repayment tenure, partially repaying a big loan amount, or even choosing a side hustle to make some extra cash. At the end of the day, inflation affects lenders and borrowers. The only difference would be how you tackle the rising costs and loan repayment with the options at your disposal.