If inflation is 5% and mortgage int 5% are we borrowing for free?

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paddywhacker

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I need to settle an argument between me and a mate? He reckons that if inflation is at 5% and mortgage lending rates are also around the 5%ish mark, then we are effectively borrowing money for free at the moment.
I can't quite get my head around the mechanics of it, but he works in finance and is convinced he's right.
If so happy days, but it can't be right surely?:confused:
 
Inflation will go towards eating away the 'value of the debt' you owe - i.e. if you owe 100e and inflation is @ 5%, then that 100e will buy 5% less the next year. However this is only good if your earnings are increasing in line with inflation.
 
If 5%/5% was free then 5%/3%, say, would be giving money away.

But would you really fill your boots with a 3% loan, if inflation was 5%. Only if you could buy thousands of representative consumer goods and either keep them for your own future consumption or sell a year later with a 5% increase.
 
Also ... if you don't have a mortgage then isn't it arguably the case that HICP inflation at 3% is the rate relevant to you rather than CPI inflation at 5% which includes mortgage costs. So pay off your mortgage and the rate of inflation applicable to you falls?
 
Are we talking about general price inflation or wage inflation, its an important distinction.
 
An interesting topic. I am not sure that your question is constructed correctly. You have to look at specific situations to assess the impact of inflation on you.

Assuming we are talking about general price inflation - i.e. the rise in the Consumer Price Index. If you have money on deposit at 3% and inflation is at 5%, the purchasing power of your money is going down in real terms. In 10 years' time, you will be able to buy a lot less.

If you buy a property with a mortgage at 5%, and you get 5% rental income and the property rises by 3% a year on average, you will make a profit.

If general inflation is 5%, but house prices drop by 10% a year, then you will lose money.

If you borrow €10,000 to pay for a holiday and pay 5% interest on an interest only loan. The €10,000 will be a lot easier to pay off after 5 years or 10 years if prices and incomes rise at 5% a year.
 
Price inflation has no impact on the relative size of outstanding debt, wage inflation does.
 
Inflation, in whatever form, in measured against a range of goods which you can buy at a certain point in time against the same range of goods at a fixed time later.

When you use your creadit card to buy a load of shopping it is not inconceivable that the range of items in your basket will have increased the next time you make the same purchase - buying on credit a good thing as long as you pay less in interest than the rate of increase.

When you get a mortgage it's somewhat different as you don't buy a basket of groceries, you buy a single item. So the measure of whether you're getting money for free is based on whether that single item will have increased in value over the period of the loan by a greater amount that the cost of servicing the loan. Whether the price of eggs has increased exponentially has no relevance as that's not what you took out the loan for.
 
the op question is in relation to a mortgage,his friend thinks that he is gaining something because inflation and interest rates are at 5%,in one way he is gaining a 5%devalue on the euro value amount at the time he purchased his property,but he still has to pay the 5%interest on todays euro value...inflatin will hurt anyone with money in the bank at below say 6% allowing for dirt tax
 
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