A question about inflation and mortgages?

[warp9]

Hi. I understand the principle that if you have savings and the rate of interest is lower than inflation, then you are going to become worse off over time.

However, does the same principle apply with a mortgage, or any loan for that matter? Would your mortgage in effect reduce in real term over time if the rate of inflation is higher than the interest?
Thanks

[1point7bar]

There any many types of mortgage and inflation also comes in different guises.

Inflation can mean you get paid more and would make paying a fixed term mortgage easier.

[bogie]

in simple terms yes, pretty much what the govt uses inflation for ..to write down their debt ...if they own tons of money, just keep inflation high for a few years and in real terms the debt is reduced

so yours is too ...so long as your wages keep pace with inflation of course......

[98elise]

As long as wages go up, then debts are reduce (in real terms) by inflation.

My Dads first mortgage was around 3k, mine was around 30k, currently its going to be something like £100k for a ftb.

Thats due to inflation, and is why I've gone interest only on my latest 25 year mortgage. In 25 years, it will probably be the price of a second hand car, so why struggle to pay it off in the early years?

[CYMR0]

98elise said:

so why struggle to pay it off in the early years?

Because of the miracle of compound interest - a small overpayment means a big reduction in the principal outstanding.

Of course that depends on your financial needs now and in the future, and the more you expect your income to rise anyway, the less incentive there is to pay off more early. Of course if you get that calculation wrong, you could be older and skinter than you planned.

[keith333]

If inflation helps increase the value of the asset that your mortgage is linked to, then yes you should load up with debt.

[warp9]

keith333 said:

If inflation helps increase the value of the asset that your mortgage is linked to, then yes you should load up with debt.

This is where we're at. Considering upgrading to a larger property and taking on a chunky mortgage. While we can afford the repayments, it will leave our monthly budgets a bit tighter. Long term cheap money vs an imploding Eurozone and potential deeper recession.

Crystal ball anyone?

[98elise]

CYMR0 said:

Because of the miracle of compound interest - a small overpayment means a big reduction in the principal outstanding.

Of course that depends on your financial needs now and in the future, and the more you expect your income to rise anyway, the less incentive there is to pay off more early. Of course if you get that calculation wrong, you could be older and skinter than you planned.

Compounding only works if you ignore inflation. I could pay off my original mortgage with a couple of years savings, but all the original repayments were a struggle.

[mcbook]

98elise said:

Thats due to inflation, and is why I've gone interest only on my latest 25 year mortgage. In 25 years, it will probably be the price of a second hand car, so why struggle to pay it off in the early years?

I'm not saying that course of action isn't right for you but it landed a lot of endowment mortgage buyers in the sh.it.

[CYMR0]

98elise said:

Compounding only works if you ignore inflation. I could pay off my original mortgage with a couple of years savings, but all the original repayments were a struggle.

Compounding works if you exclude inflation, not ignore it altogether... if the interest rate is higher than wage and savings inflation (as is usually the case) then paying off early still makes sense.

[warp9]

CYMR0 said:

if the interest rate is higher than wage and savings inflation (as is usually the case) then paying off early still makes sense.

But that is not the case at the moment. Non?

[CYMR0]

warp9 said:

CYMR0 said:

if the interest rate is higher than wage and savings inflation (as is usually the case) then paying off early still makes sense.

But that is not the case at the moment. Non?

Depends ... if you have a pre-2007 mortgage that's not fixed at some crazy rate, it's unlikely to be the case. If you've got a more recent mortgage, there's a very good chance that you're paying 5%+.

[sideways sid]

There are two questions here.

To answer the OP's first one, the mortgage does effectively devalue if wages and house prices rise due to inflation.

The second one is comparing interest-only and capital repayment mortgages, and the benefit of interest-only becomes apparent only if the return earned on the capital part of the monthly payment, exceeds the cost of it. Its nothing to do with inflation. i.e. borrow £100k and pay it down over 25 years on a repayment mortgage, or pay interest-only, investing the capital part to build a £100k pot in less than 25 years. This can be seen as a higher-risk choice, but potentially with commensurately higher rewards.

[98elise]

CYMR0 said:

98elise said:

Compounding only works if you ignore inflation. I could pay off my original mortgage with a couple of years savings, but all the original repayments were a struggle.

Compounding works if you exclude inflation, not ignore it altogether... if the interest rate is higher than wage and savings inflation (as is usually the case) then paying off early still makes sense.

My point was that early on my mortgage was a massive drain on my finances. IO would have helped me a lot. Many years down the line and the mortgage repayments were a tiny part of my salary, and i could easy pay the capital off with a few years hard saving.

The figures were something like 10k salary (someing like £750 take home PCM) with the 30k mortgage costing me £300 per month. I really struggled in the early years. If you can afford to over pay, then there is some benefit in it, but you see this late in the mortgage, when inflation has taken the edge off it anyway.