Inflation is the gradual increase in the general price level of goods and services within an economy over time. It erodes the purchasing power of money, making each unit worth less, and is influenced by factors like demand, supply, and economic conditions.
Inflation and loan repayments are connected because there is an increase in loan interest rates during inflation. Why? Due to the rise in the price of commodities, the value of money drops, and lenders risk incurring losses. To receive actual returns, lenders charge higher interest rates than when there is no inflation.
Inflation can affect the country's economy, and loans are one of the areas where one can see the prominent effect of inflation. Read further to learn how a borrower can effectively manage the impact of inflation on loan repayment.
How to effectively manage the impact of inflation on loan repayments
To effectively mitigate the impact of inflation on loan repayment, here are some strategies to adopt:
#1. Prepayment and reduction of debt
The value of money keeps dropping during inflation. Therefore, settling your debts as soon as possible is better. The outstanding amount and the long-term liability are reduced when you make extra payments. So, the decrease in the outstanding amount allows you to pay less EMI.
However, prepayment does come with extra charges, and some loans have a lock-in period, so it would be best to consult with your lender before making the decision.
#2. Find better rates and offers
During inflation, as interest rates increase, financial institutions offer competitive rates to attract more customers. You can find a lender with interest rates you can work with. If you already have a loan, you can port to another lender offering better interest rates.
Additionally, financial institutions offer various repayment methods with flexible terms and conditions during such periods. You can switch to the one that gives you better benefits.
#3. Longer Repayment Term
Inflation causes a rise in the cost of living, and a temporary means of alleviating financial strain is opting for a longer repayment term. This will help reduce the monthly funds you pay, offering you more financial flexibility. The extra funds you realise from the lower payment can also be used on investment opportunities that will yield more profit.
It is essential to know that extending a loan term depends on the lender's internal policies and the specific terms of the loan. Some lenders offer a tenure extension for only a few new loans.
#4. Refinancing
This financial strategy centres on replacing an existing loan with a new one, usually offering favourable terms. This strategy allows borrowers to benefit from changes in interest rates, market conditions, or financial status. You can approach your lender to provide a new loan with improved terms or adjust the loan terms, such as loan repayment terms and interest rates, to suit your current financial conditions.
#5. Fixed Interest Rate
A variable interest rate means inflation can affect your interest rate, while a fixed interest rate remains stable throughout the loan term. Opting for a fixed interest rate protects you against the impact of inflation on loan repayment. It also helps in budget planning, as you know the fixed interest you pay monthly or annually. If you are about to obtain a new loan, you can opt for a fixed interest rate, and if you are already on an existing loan, you can approach your lender to change your interest rate from variable to fixed.
Conclusion
Inflation and loan repayments are directly related. If inflation increases, loan rates increase as well. Therefore, it is crucial that you prudently manage your monthly expenses. However, there are effective strategies you can use to cushion the increase in interest rate, such as prepayment and extension of the loan tenure. If you are not meeting up with your loan repayment due to the impact of inflation on loan repayment, you can reach out to your lender and work out a solution together.
Tata Capital offers a variety of loan types like home loan, personal loan and business loan at great interest rates to help you make the best decision on which loan type to go for.
FAQs
1. How does inflation affect loan repayments?
How inflation affects loan repayments can be understood by the fact that inflation causes the value of money to decrease due to the persistent increase in the price of goods and services. Because of the decrease in the purchasing power of money, lenders often find themselves at a loss, and they tend to compensate for it by increasing the interest rate. Hence, loan repayments and inflation affect each other.
#2. What can I do to protect myself from the impact of inflation on my loan repayment?
The inflation impact on loan repayment can be mitigated by following these strategies.
#●Make extra payments to reduce your outstanding balance and negotiate with your lender to reduce your monthly payments.
#●Discuss with your lender to extend your loan repayment period; this will help to reduce the financial strain and offer you more financial flexibility.
#●Seek a lender with more convenient terms and conditions and transfer your outstanding balance.
#3. What happens if I can't afford my loan payments due to Inflation?
If you can't afford to pay the loan due to inflation, then it is best to inform your lender as soon as possible. Based on the type of loan and its terms, your lender can help by extending your loan duration, temporarily postponing your payments, or modifying the terms and conditions attached to your loan.
11 September 2023
5 mins read
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