When Inflation Is Your Friend

Child holding paper house in hands against spring green backgroundBuying a property is the goal of most of us but it seems so daunting – huge price, mortgage, debt.  As parents we might feel even more daunted because we face extra costs looking after our child with additional needs. Added to this, we are also likely to be trying to figure out how we can leave our child something, anything so they are not completely reliant on the government to live their lives.  Quite frankly, it all seems overwhelming.

So buying a property can sometimes feel like another massive hurdle.  In the UK prices seem to rise continuously, and this is also true for other parts of the world.  But if it’s feasible, leaving an asset like a property is one brick (if you pardon the pun) of many in the plan to leave our children financially healthy.

Yet a figure like £200,000 is a big number, many more times than average salaries.  The question is: how can we make this number smaller?  I don’t have an answer to that, but with a bit of knowledge about inflation it will seem smaller if you intend to live in that property for a long time.  With inflation, in real terms, that £200,000 value will half in value over the years.  That is, inflation can make it easier to pay off your mortgage.

Before we look at the maths, let’s think back to when our parents took us on our first holidayInflation notes going into grinder coming out as coins
when we were children.  I don’t know where you went or what it cost, but let’s say it was two weeks wages.  Let’s say it was £200 back in the early ’80s.  That £200 bought a week’s worth of fun for the whole family.  Today that £200 would barely buy your same family a day out with a meal at the end, let alone a whole week.  Getting the picture.  As prices rise and wages go up, money is worth less.

And so it is with property.  To buy a property in the beginning is more expensive than rent.  You not only have to pay the interest costs of the mortgage but also pay some back to the original loan.  You have to stretch yourself to buy insurance and do whatever repairs yourself, out of your own pocket.  But once you get in to the property, and with a little time, it starts to pay dividends.

Rents rise with inflation.  Mortgages rise with interest rates and fall when interest rates fall.  But the actual cost of that property, in real money terms, falls with time.  Inflation makes that £200,000 seem like only £100,000 in actual cost out of your pocket terms.

Let’s talk about inflation more.  Inflation is the percentage that prices increased as an average over the year.  There are several different ways of measuring it, depending upon how politicians want to make the figures look good for their own ends.  But let’s agree that inflation is a simple measure of how much prices when up in a calendar year.  Let’s say from the 1st January to the 31st December of that same year.

If they went up by 5% that means a loaf of bread that cost 1.00 when you made your New Year’s breakfast (assuming it wasn’t in the January sales!), then come the end of the year when A green percent or percentage symbol in a shopping cart to represent comparison hunting for the best or lowest interest rate or inflation affecting prices for products you want to buyyou’re planning your New Year’s Eve party that same loaf would cost 1.05.

Providing you got a pay rise of 5% you’d be no worse off.  However, if your pay only went up by 1%, as it has for many public sector workers in the UK, you’d find prices are going up faster than your income and there only so much belt tightening we can all do.

But inflation can be our friend too at least when it comes to property.  In financial terms there is a rough rule of thumb called the Rule of 70.  This is a formula to determine how many years it takes the value of money to half in real terms.  It is:

70 divided by the annual rate of inflation   =   number of years value of money halves

For example,

70 divided by 5% inflation   =   14 years for the value of money to half

Model house on a stack of coins representing high prices on real estate marketTo relate that to a property purchase of £200,000, this would mean in 14 years the money value in real terms would be £100,000. This means that when you think of how much you owe on your house it’s no longer the original sum of 200,000 but actually closer to £100,000 – half in real terms.  Why because in 14 years time what we think of today as £200,000 is only worth £100,000 in terms of what we can purchase with it. This means that your mortgage payments although they may still be around the same amount, but in real terms when you look at your total income they will be an awful lot less.

And of course the actual value of the property would have increased, quite a lot if current house prices keep going up as they have at least in the UK and Australia and some parts of the USA. So your house might be worth £300,000. So the key is to get on the property ladder and hang in there.

Now obviously i’m not suggesting that anyone should buy a property just because inflation is rising.  There are many other considerations and of course higher inflation also means higher day to day living costs which may impact on the ability to meet those mortgage payment.  You should take independent financial advice from a regulated advisor.

But why tell you all this?  Well many people, at least in the UK, have been put off purchasing a property because the prices seem crazy. Yes, they are but you have to balance this desire not to join the crazy people with the knowledge that if you can afford to get that deposit together and meet the monthly repayments, then in the long term buying is still a good option.  Your home can also be one part of the financial legacy you are planning to leave to your child with additional needs so they are assured of a secure financial future.