Inflation, defined as the sustained increase in the general price level of goods and services over time, can significantly impact the economy and individuals’ financial situations.
When taking out a loan, inflation is a critical factor to consider, as it can affect both the cost of borrowing and the borrower’s ability to repay.
In this article, we’ll explore the key considerations for taking a loan during periods of inflation, including an overview of different types of loans and factors affecting loan approvals.
Understanding Types of Loans
When considering borrowing during inflation, it’s essential to understand the various types of loans available and their implications. Choosing the wrong type of loan could have long-lasting financial repercussions, potentially leading you from the frying pan into the fire.
Personal loans, for instance, are unsecured loans that typically come with higher interest rates than secured loans. This type of loan is often referred to as instalment credit, in which you pay back small increments with interest over time. Credit cards and lines of credit are types of personal loans. If you default on these loans, your credit score will go down and you’ll go to collections.
Secured loans require collateral, such as a car or house, and typically come with lower interest rates. Title loans and mortgages are examples of secured loans. The repercussion for defaulting on this type of loan is collateral repossession — in other words, the lender will take your collateral to make up for their losses.
Some of the common types of loans to choose from include:
Title Loans
Difficulties securing a traditional loan have many borrowers exploring title loans. Before you start searching for the “title loan value of my car,” there are a few pros and cons to consider. Title loans allow borrowers to use the value of their vehicle as collateral. The loan amount is typically based on the car’s value, and borrowers may be able to borrow up to the total value.
Title loans are short-term secured loans with higher-interest rates and fees than traditional loans. Yet, they’re accessible to those facing an emergency or with poor credit scores. Understanding the terms and developing a solid repayment plan before taking this loan is crucial.
This type of loan is beneficial if you find yourself in a tight spot and can’t get a traditional loan. For example, if your loved one gets stranded while traveling and needs a last-minute plane ticket or an unexpected expense leaves you unable to pay rent, especially now, when there are known problems with some of the biggest banks, as you can see in the below-mentioned video.
Home Equity Loans
Home equity loans are secured, mid-term loans with low-interest rates. With this loan, you’re borrowing against your home, listing your property as collateral. If you fail to repay this loan, you could lose your home. As such, understand the terms and develop a solid repayment plan before proceeding.
Home equity loans are meant for large sums of cash with longer repayment terms. For example, you likely wouldn’t take a home equity loan to pay for $1000 in car repairs, but you might take one to pay for your child’s college tuition or renovations.
Lines of Credit
Lines of credit are a low-interest alternative to credit cards, typically reserved for those with a good credit score. This loan option is designed for long-term use. Many borrowers transfer high-interest debt to their lines of credit to offset interest costs.
A line of credit can be difficult to get if you have a low credit score or high debt ratio. The terms and collateral requirements vary on a case-by-case basis.
Bank Approvals During Inflation
Banks often become more cautious about lending money during periods of inflation. Inflation can erode the value of money over time, making it riskier for banks to lend money that may not be repaid with the same value.
The OCC suggests that higher inflation can lead to stronger nominal GDP growth, which can drive up bank credit and revenues at a more rapid pace than in a low inflation environment. The New York Times discusses how the Fed has raised interest rates to contain rapid inflation, which could have implications for the banking industry.
Here are the measurements of consequences for smaller vs. larger banks during inflation, according to the OCC study mentioned above:
| Metric | Small Banks | Large Banks |
|---|---|---|
| Loan-to-Deposit Ratio | 71% | 58% |
| Noninterest-Bearing Deposits | Lower | Higher |
| Liquid Assets (share of balance) | Lower | Higher |
| Trading Assets (percentage) | Lower | Higher |
| Revenues from Nontrading Activities | Higher | Lower |
When considering loan applications, banks look at the borrower’s credit history, income, and debt-to-income ratio. In times of inflation, banks may also consider other factors, such as the borrower’s industry or the inflation rate.
Banks have historically responded to inflation by tightening lending requirements or increasing interest rates to offset risks. This excessive caution can make getting a loan difficult for people with existing debt or poor credit.
It’s important to have a strong credit history, stable income, and a manageable debt-to-income ratio to increase your chances of loan approval during inflation. If you have a rocky credit history, consider offering collateral or a co-signer to reduce the lender’s risk or explore alternative lending options.
In conclusion, taking out a loan during inflation requires careful consideration of both the borrower’s financial situation and the current economic conditions. While various types of loans are available, borrowers must understand the risks and benefits of each.