Impact of Inflation and Recession on Debt Repayment

by Nathan Sugeng, CIRP, LIT
May 11, 2023

Inflation is a sustained increase in the general level of prices for goods and services in an economy over a period of time. It means that the purchasing power of money decreases as the cost of goods and services rises. Inflation is usually measured as the percentage change in the Consumer Price Index (CPI), which tracks the prices of a basket of goods and services consumed by households. Since inflation reduces the purchasing power of money, the same amount of money will be worth less in the future and this will make it more difficult for borrowers to pay back their debt because they will need to spend more money to buy the same goods and services. In other words, if the cost of goods and services go up and your income remains the same (or does not increase at the same rate as the increase in expenses) then your budget gets squeezed. For example, let’s say if your income is $3,000 per month and your monthly living expenses (food, clothing, utilities, fuel, etc.) are $2,000 per month then this would leave you with $1,000 for you to pay your mortgage. If through inflation your monthly living expenses rises to $2,200 per month, and your income does not change, you would now only have $800 to pay for your mortgage. Inflation may also lead to higher interest rates, which makes borrowing more expensive especially if your loan has a variable interest rate. The increased borrowing costs will also put additional strain on your budget.

Here are some strategies you can use to decrease the impact inflation has on your ability to pay back debt:

  1. Refinance your debt. Convert debt with high interest rates such as credit cards to a credit facility that has a lower interest rate such as a line of credit or a fixed rate term loan.
  2. Increase your income. Negotiate a raise, work more hours if possible, or start a side job.
  3. Cut expenses where possible. Look to decrease or eliminate non-essential expenses such as dining out, entertainment or subscription services.
  4. Invest in assets that appreciate in value. These investments can help offset the impact of inflation by providing a return that is higher than the inflation rate.
  5. Consider inflation-indexed debt. Some types of debt such as inflation indexed bonds, are designed to adjust for inflation.

A recession on the other hand, is a significant decline in economic activity that persists for a prolonged period of time, usually lasting for at least six months. During a recession, economic indicators such as Gross Domestic Product (GDP), employment, industrial production, and retail sales decline significantly. During a recession, people may experience a decrease in income or loss of employment, which can make it more difficult to pay back debt. This can be particularly challenging for people who have high levels of debt or who are living paycheck-to-paycheck. In addition, during a recession, lenders may be less willing to extend credit, which can make it difficult for people to obtain new loans or refinance existing debt.

Here are some strategies you can use to decrease the impact a recession has on your ability to pay back debt:

  1. Build an emergency fund. Try and build an emergency fund with three to six month’s worth of living expenses saved up.
  2. Prioritize debt repayment. If you have multiple debts, prioritize the ones with the highest interest rates, like credit cards, or the ones that are most critical, such as mortgage payments.
  3. Negotiate with creditors. You may be able to negotiate a lower interest rate, lower monthly payments, or a temporary deferment or forbearance on your debts.
  4. Consider debt consolidation. If you have multiple debts with high interest rates, you may be able to consolidate them into a single loan with a lower interest rate.
  5. Seek help from a Licensed Insolvency Trustee. They can help you develop a budget, prioritize your debts and explore other options for managing your debt.

Overall, inflation and recession can both impact a person's ability to pay back debt, but the specific impact will depend on the individual's financial situation and the severity of the economic conditions. It's important to regularly monitor your debt levels and create a plan for managing your debt during times of economic uncertainty.

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