Inflation does more than push up prices at the store — it also makes borrowing more expensive because banks need to raise interest rates to cover the loss of purchasing power of the money they are loaning out, since they are getting repaid with “cheaper dollars”.
When prices rise faster than wages, household money shortages lead to mounting debt. And, unless you have a fixed interest rate lown, your monthly payments on loans and credit cards will climb higher each month. With these rising costs, you need a clear plan for tackling debt.
The Impact of Inflation on Debt
When inflation rises, it affects your debts in two different ways. Rising prices change how much your debt really costs. With variable-rate loans, like credit cards and adjustable mortgages, your monthly payments increase as the Federal Reserve raises rates to combat inflation.
Fixed-rate loans, like traditional mortgages or car loans, tell a different story — you pay them back with money that’s worth less than when you first borrowed it. However, the fixed-rate benefit only helps if your income keeps pace with rising prices. In this case, lenders lose because you’re paying them with money that’s worth less than when they gave you the loan.
Remember, higher prices also drive more people to seek loans for big purchases, leading banks to charge higher interest rates on new loans. While this benefits lenders through increased profits, it makes new borrowing more expensive for everyone. Understanding how inflation affects different types of debt helps you make smarter choices about which ones to pay first.
Prioritize High-Interest, Variable-Rate Debt
Market interest rates affect your monthly loan payments. When inflation rises, loans with changing interest rates become dangerous. Your monthly payments increase as market interest rates rise, making these debts harder to manage over time. Before taking on new variable-rate loans, consider how future rate increases might affect your monthly budget. Check if you can still afford payments if rates rise by one or two percentage points.
Many experts recommend the debt avalanche method —i.e., listing your debts from highest to lowest interest rate and attacking the highest-rate debt first while making minimum payments on others. When you pay off the highest rate debt, focus on to the next highest rate.
Another method is the “Debt-Snowball” method. In this method you start with the smallest debt and pay it off first even if it has a lower interest rate. When you pay it off, it helps you feel like you are accomplishing something, so you have positive reinforcement. You then take the money that was going toward that small debt and put it towards the next biggest debt.
Additionally, balance transfer offers can be used to move high-interest credit card debt to cards with lower fixed rates. Some banks even offer an introductory zero interest rate for 12 to 18 months for borrowers with good credit ratings. For example you can get the 0% Quicksilver Card from Capital One. Rather than paying the 3% transfer fee, the best way to handle this is to charge absolutely everything you buy on the Zero percent card and use the money you would have spent to pay off the high interest card first. Hopefully, by the time the zero percent rate expires you will have your high interest rate cards paid off and you can pay off the new card.
For other variable-rate debts, contact your lender early if you worry about making payments. They might offer options to adjust your loan terms or consolidate into a fixed-rate loan that keeps your payments steady. Lenders are incentivized to help you when it’s reasonable and may adjust your terms so you stay on track.
Fixed Rate, Long Term Debt: A Low Priority
Long-term loans with steady interest rates work differently during inflation. Your fixed-rate mortgage or student loan payments stay the same while prices change around you. These set payments become easier to manage as wages rise with inflation.
Some private lenders offer flexible repayment options for student loans during tough times. They can provide several ways to handle payments based on your situation. You might qualify for payment breaks or longer repayment schedules if you face financial challenges.
Consider making extra payments when your budget allows, but weigh this against other financial goals. Before changing your payment strategy or if you expect payment troubles, contact your lender — they can explain your options and help you create a workable plan.
Practical Tips for Building a Debt Repayment Plan
Creating a strong plan to pay off debt means finding the right balance between payments and savings. A careful strategy helps you manage both current debts and future expenses. Here’s how to build your plan:
- Make a list of all your debts and order them by interest rate.
- Look at your monthly spending to find extra money for debt payment.
- Set up a clear budget showing how much you can pay toward each debt.
- Put any extra money toward your highest-interest debt first. (Yard sales, eBay, etc).
- Begin with smaller extra payments if that’s all you can manage.
- Check your progress each month and adjust as your finances change.
- Look for ways to increase your debt payments over time.
While paying down debt is important, maintaining emergency savings is equally crucial. Keep your emergency fund in a high-yield savings account, which offers significantly better interest rates than traditional savings accounts.
This approach serves two purposes: your emergency money grows faster while remaining liquid and accessible when unexpected expenses arise. Many online banks offer high-yield accounts with rates 10-20 times higher than traditional banks, with no minimum balance requirements or monthly fees. Having this financial cushion prevents you from accumulating new debt when emergencies happen.
Stick to your plan, and remember that every payment helps reduce your debt and thus you pay less interest in the long-run. Focus on the “big-picture” rather than just paying enough to get by. Regular reviews of your budget and savings will help you stay on track toward your goals.
Conclusion
Smart debt management matters more as inflation changes. When inflation is high, focus on paying down debts with changing interest rates first. Make regular payments on your fixed-rate loans and keep building your savings.
As inflation cools, consider different approaches to your debt, like using credit lines for major expenses while keeping your emergency fund in high-yield accounts. Every financial decision during changing inflation requires careful thought about which debts to pay first and how to protect your savings.
Remember that your debt strategy should change with economic conditions. What works during high inflation might not work as rates fall. Keep reviewing your debt payments, savings plans, and overall financial goals. Every financial decision during changing inflation requires careful thought about which debts to pay first and how to protect your savings.
You might also like:
- Have Wages Kept up with Inflation?
- Inflation and Retirees
- 2025 Social Security COLA
- How to Get Money Interest Free
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