Inflation can be a useful tool in paying down your mortgage, one of New Zealand’s leading property investors has claimed.
But that’s only if you’re one of the lucky Kiwis to enjoy wage growth in line with inflation.
Nick Gentle, who is the co-owner of iFindProperty, says that during periods of rising inflation, like the one New Zealand is facing now, mortgage debts shrink in real terms.
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As people’s incomes rise with inflation, they are able to pay off more of their mortgage debt. It’s one small silver lining in the cloud of rising interest rates and consumer goods prices.
The theory is that as inflation bites, wages, salaries and rents go up in relatively equal measures. At the same time the mortgage debt as a percentage of that income becomes less because the size of the loan stays static.
As each dollar is worth less in real terms, so is the outstanding debt. If inflation is running at nearly 7%, as it is now, the outstanding capital is in effect shrinking by the same amount because as wages and rents go up, the outstanding debt stays static.
Gentle cites the example of a $500,000 loan on interest only with inflation at 5%. The debt is still $500,000, but if income is rising with inflation, the relative value of that debt compared to when it was borrowed is $475,000. After five years with inflation running at 5%, that $500,000 loan is equivalent to $386,890.
“In the 1980s interest rates were high, everything was going up, but then incomes went up,” Gentle says. “You came out the other side with a mortgage that was nothing compared to what you probably started with 10 years ago.”
He adds: “In theory, if inflation is running at 5% for four or five years, a fifth to a quarter of your mortgage will magically disappear.”
Not everyone is seeing their income rise currently. Statisics New Zealand reported that wage inflation rose to 3% in the first quarter of March. However, anecdotal reports in relation to the great resignation suggest that New Zealanders are switching jobs for better income.
Investors also benefit if rents rise, which is expected in inflationary times. That makes paying their existing debt easier.
Gentle adds: “It’s important to point out that people don’t live in a vacuum. Inflation is incredibly damaging. It’s not like you sit there in a bubble and your mortgage goes down, and everything else is holding hands and singing songs. This is of course only one side of inflation. It’s a really tumultuous time. Inflation is a complicated beast and eroding your debt is only one aspect of it.”
House prices and mortgage debts have increased in the last two years. Photo / Ted Baghurst
Mortgage interest rates have risen thanks to measures taken by the Reserve Bank of New Zealand to quell inflation. That means fortnightly or monthly repayments are more expensive for borrowers who have not fixed for a good long period. The cost of owning property, such as insurance, rates and repairs, is also going up, Gentle adds.
“The idea is that you grind it out and hold on. At the end [of the inflationary period] your mortgage is still the same as whatever it was when you started, but your [income] has risen.”
Even though property prices aren’t rising currently, they do follow inflation over the long run, says financial adviser Michael Cave, of Cave Financial. “The key is people [might have] borrowed $700,000 or $800,000 on a $1m property,” he says, adding that in five years’ time the value of the property should have grown along with income, but the debt is more manageable.
Gentle has $6m worth of mortgages over his investment property portfolio. He fixed all his mortgages for five years in 2021 when economists were talking about impending inflation. Anyone who did this is even better off because their repayments on mortgage debt don’t rise, but their income does.
Cave points out that even if the outstanding mortgage debt is shrinking in real terms, interest rates have gone up so it is worth paying down debt if possible. “Yes, there’s an inflationary benefit for not paying it down, but you’re also paying interest, [which is] the cost of having that debt. It’s still a good concept to pay down debt and increase the equity in your property.” What’s more, the higher the interest rate, the higher the return on reducing debt.
Another point is that inflation magically reducing the mortgage only works for people who have borrowed all they intend to. It doesn’t necessarily work for people who are trading up houses, says Gentle. “You’re re-entering the mortgage market every time.”
