Inflation won't spur people to take out big mortgages like it used to
For years home buyers took out big mortgages knowing inflation will ease the burden of repayment. That no longer makes quite the same sense, says Merryn Somerset Webb.
I noticed at tweet a few nights ago from Duncan Weldon. It went like this:"Some fretting about UK deflation. Genuine question: in the absence of wage falls how do falling energy/food costs make debt less repayable?"
If prices are flat and your wages are flat, the value of your debt hasn't changed. Nothing is better or worse than it was. You borrowed the money. You have to pay the money back. So it doesn't make debt less repayable in theory.
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What it does do is something rather different. It destroys the rationale a lot of us use when we borrow money in the first place. I've made this point before, but anyone over, say 45, might want to look back to the purchase of their first home.
Did you prudently borrow just as much as you thought you could pay back on a monthly basis while having a little left over to live a happy life? Did you hell. What you actually did was to borrow as much money as was conceivably possible in the happy knowledge that inflation would erode the real value of that debt and make it more or less go away.
A £2,000-a-month mortgage payment isn't going to break the bank after 20years of inflation averaging 6% (the real cost will be down to £500-£600).
So, assuming your wages have kept up with inflation (if you took out your mortgage in your 20s or 30s, they should have wiped the floor with inflation), you are on easy street. Borrow big and inflation will make you rich.
This is something that has long been a universally acknowledged truth in the UK. But what happens if there is no inflation? You can't assume the same fair wind.
And while that doesn't make your debt less repayable in real terms, it makes it much, much more of a long-term burden. And once you understand that (and it doesn't take long for a deflationary mindset to set in ask the Japanese) it also makes you less likely to borrow big again.
That's why deflation matters to a deeply indebted society in a way that it just doesn't to a solvent one. It's all about psychology.
* If you haven't any debt to worry about, falling prices should just raise your standard of living. Hooray.
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