Rent or Buy? – Part 5 (Inflation)

inflationInflation has effect on all kind of financial decisions. Deciding between buying or renting is not an exception. But how much can inflation impact the final outcome of your decision? Let’s see the numbers!

We saw in the previous chapters that there are a number of factors that you should take into consideration. And almost all of these will be influenced by inflation:

  • Property prices – although property prices do have their up and down cycles, on a long term their value increase with the same rate as inflation
  • Rental fees – You should have no doubt about this; your landlord will increase your rent with inflation.
  • Housing costs – your maintenance fees, utility costs etc. will all increase with inflation. Taxes too, as even if there is no tax rate increase, these are generally linked to the property value (back to the first point)
  • (Variable) mortgage interest rates – This is a bit more tricky. There is not direct link between mortgage interest rates and inflation. Nevertheless when inflation is higher, mortgage interest rates also tend to be higher and the other way around.
  • Your income – This is also not set into stone as you might get a promotion or just as well get fired (not with all capitals 🙂 ). But on an average your salary should also get increased with at least the rate of inflation.
  • Your return on investment – On a long term, historically the value of the stock market increase by 6.8% above inflation.

There is only one thing that doesn’t get affected by inflation, ant this is your fixed mortgage interest rate. Why is it important? Because the higher the inflation, the relatively less you need to spend on your mortgage.

Let’s take a simple example: Your mortgage is EUR 1,000 per month and your monthly net income is EUR 3,000. This means you pay 33% of your net income on mortgage. Calculating with a 2% inflation and taking that your income will only get increased by this amount, after 5 years your net income will be EUR 3,312, which means that only 30% will be spent on mortgage. After 10 years this ratio will be 27% (by the way is after 10 years your income is only increased with the rate of inflation, you’re doing something wrong). You would not have such advantage due to inflation if you have rented.

Are there situations when the effect of inflation can especially be in your advantage? In my view yes; and in many countries we are just living those years. You need:

  • low mortgage rates – check
  • increasing inflation in the future – I’m quite confident that if not in the next 1 or 2 years, the huge amount of extra money that the ECB/FED has printed will eventually speed up the inflation. I cannot imagine that the average annual inflation rate during the next 10/15/20 (put a number here for the years you want to have your mortgage for) years will be less than 2%.

The above can also affect the math around whether it would worth to pay off your mortgage early or not. This will be a subject of a later post.

Should everyone run to buy a property now? Just because of this, definitely not. Inflation is only one of the factors to consider when buying (or not buying) a property. In addition, other factors, especially the price to rent ratio and ownership costs has much more impact on whether it really worth to buy your own home. Nevertheless you should definitely not forget about the beneficial effect of inflation if you really decide to take that mortgage offer.

Do you consider the effect of inflation during your mortgage payments? Do you have anything else to add? Please feel free to comment!

 

Please subscribe to the weekly newsletter and never miss a new post!

(Visited 48 times, 1 visits today)

4 Comments

  1. Amber from Red Two Green November 7, 2016
    • Roadrunner November 7, 2016
  2. Mustard Seed Money November 8, 2016
    • Roadrunner November 8, 2016

Leave a Reply