The word inflation is offensive to many people.
In fact, the thought of increasing inflation produces negative connotations because we know that each year, because of inflation, we end up paying more for everything.
But here's the thing…
While inflation is the enemy of the average Australian, especially for those with savings which get slowly eroded over time, inflation actually helps property investors as their assets increase in value due to inflation.
So, while those who are dependent on the interest on their savings find the value of their nest egg eroding in real (after inflation) value, for those who own real estate, inflation pushes up the value of their asset – usually significantly more than the general inflation rate, as inflation in construction costs and land values increases significantly above the general inflation rate.
The impact of inflation
As a property owner, you get a double whammy…
While inflation increases the price of your properties, if you decided not to pay down the mortgage on your home for example, and just pay interest only, your property will increase in value but your mortgage will remain the same in dollar terms.
But, the true value of your debt is being eroded by inflation.
Of course, you’ll still need to pay off your $400,000 mortgage one day – but when you pay the it back in say 10 years, $400,000 won’t be worth as much as it is today.
And that's a pretty good result if you ask me!
Let’s look at this in a little more detail:
Sure inflation in Australia, and in fact in most developed countries, is on the low side at present, but during the 2000’s Australia’s inflation remained stable around 3%.
If the inflation rate is three per cent, then on a $400,000 loan the true value of that debt is reduced by three per cent each year, which is $12,000 or $230 a week!
Therefore, in reality, inflation is paying off your debt faster than you probably can do it yourself!
How do you feel about inflation now?
Learning to love good debt
If you’re like me you would have been taught by your parents not to take on debt, and that when you do you should pay it off as quickly as you can.
And it just seems right to pay off your non tax deductible home loan debt as quickly as possible.
But for most property investors, this may not be the right solution.
As I’ve just explained, inflation can work its magic on your home loan -making it worth less in real dollar value - while you put your hard-earned dollars to far better use such as towards the purchase of another investment property that has "good debt" attached to it.
The secret is that good debt will actually allow the tax department to help you buy that property!
Don't believe me?
Well, in essence, tax contributes to your property purchase by putting dollars back in your pay packet via the deductions associated with investment property ownership.
In fact, it's almost like another way of getting a pay rise!
When did the bank last give you a cash bonus?
At the moment, we have low inflation in the order of 1.5 per cent, which is why we also have low interest rates.
However, when the economy strengthens, correspondingly inflation and interest rates will increase, but as I've explained, that's not necessarily a bad thing.
While we have all probably got used to a low interest rate environment, it's actually better if rates, and inflation, are higher because it means that our economy is doing better.
So, perhaps when inflation does start to rise – as it inevitably will– you won't view it a negative.
Instead, you'll hopefully see it for what it can be, which is your capital growth friend rather than an economic foe to be feared.
It can be confusing to know whether to get a variable rate or fixed rate mortgage, and what features are important. That's why it's important to not only check the right rates, but make sure that you're getting the right features in your home loan. Get help choosing the right home loan
Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.