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Does inflation affect personal debt?

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go2self
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Does inflation affect personal debt?  Reply with quote  

Does inflation affect personal debt?

Let’s apply a KISS look at it.
You take a no interest loan for 10.
Inflation is 4% per year.
One year later ten dollars can buy 9.96 worth of goods.
But you have to pay back 10.
So you dig in your pocket to make up the .04 difference (also affected but to keep it simple).

Now it really depends on what you did with the 10 for a year.
If the 10 did not gain .04 by itself, you lost.
If the 10 gained .04, you lost, because capital gains tax (16%) reduced the gain by .0064
That means you actually gained .0336.
To actually become profitable the 10 would have to earn .04166 to break even.

Now if you want to complicate it, move the decimal point a few points to the right and include interest on the loan, fees, points, tax credits…

Does this make sense?

Time is our most volatile resource that if not used immediately is lost instantly
Post Thu Aug 31, 2006 6:13 am
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coaster
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Well, I think you're both missing the effect of paying interest; and there is no such thing as a "no interest loan."

And interest and opportunity cost are always more than inflation; the market dictates it that way in order to cover the risk and the taxes, and to make some money.

Your homework assignment for today: run some numbers with inflation = 4%; opportunity cost = 7%; interest = 7%; taxes = 25%. Smile

~Tim~
Post Thu Aug 31, 2006 11:55 am
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go2self
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Munee long time no see – you may be right but what if we look at it his way.
I borrow a cup of water with a promise to repay it 1 year later.
I let the cup of water sits for 1 year and evaporation or leakage reduces the amount of water in the cup.
After a year I have to repay 1 cup of water by making up the difference from my own water supply.
My own water supply has also been similarly affected by evaporation or leakage, but I still have to provide 1 cup of water.
Now do I repay the cup of water minus evaporation or do I need to add water to make a cup?

That is why I asked the question I need help in understanding why most everyone feels that evaporation benefits the borrower but it appears the evaporation has a negative effect for the borrower. Even without interest.

Now if the lender understands effects of inflation and chose to lend the water with a few drops added each month in the lenders interest then the lender would have covered his loss due to evaporation.

Time is our most volatile resource that if not used immediately is lost instantly


Last edited by go2self on Thu Aug 31, 2006 2:46 pm; edited 4 times in total
Post Thu Aug 31, 2006 2:32 pm
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go2self
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Coaster –
Indeed there are no interest loans as a standard practice in Muslim communities and also amongst friends and families. Just the other day I had to borrow 20 bucks to pay for movie tickets.

Before I tackle the homework wouldn’t I need some kind of period to apply those numbers, or should I run it as a 1 year loan. Also need some clarification on the difference between the opportunity cost rate and interest rate on a loan?

Would the applicaion of opportunity cost suggest that the !0 be used to create a reference margin by investing in something more as opposed to investing in something less?

Luckily I just put together a calculator (mother of all free calculators) that can do just that (if you get a chance why not give the calculator a test run and review)
Wink

Time is our most volatile resource that if not used immediately is lost instantly
Post Thu Aug 31, 2006 2:32 pm
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coaster
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I was planning on running it for 10 years, with annualized rates. I just set the opportunity cost equal to the loan interest for sake of comparison; no implication of any relationship or what they are in the real world. Generally there's about a three percent spread between inflation and low-risk interest rates.

~Tim~
Post Thu Aug 31, 2006 4:38 pm
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go2self
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This is what I got. 3 revisions

INVESTMENT
100,000, 10yrs @ 7% compounded annual= 96,715.14
Annual X 10; 4% inflation (42,326.67), 25% gains tax (18,517.92) = (60,844.59)
Yield 35,870.55

DEBT
100,000, 10yrs @ 7% compounded monthly* = (39,330.18)
Annual X 10; 4% inflation** (19,638.98), 25%tax credit 8592.05 = (11,046.93)
Cost (45,415.13)

10 year = (9,544.58)*** loss of purchasing power****

close? no cigar?
*monthly vs annual payments would cost too much
**debt affected by inflation is applies as a negative value
***the original investment of 100,000 is worth 90,455.42
****since the debt is paid off we assume we must be holding something worth 125,361.02 (loan+interest cost-inflation), we hope anyway

Time is our most volatile resource that if not used immediately is lost instantly
Post Thu Aug 31, 2006 6:02 pm
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coaster
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I'll have to look at it later. I've got a sick cat today. Not the one in the avatar; another one. Sad

~Tim~
Post Thu Aug 31, 2006 7:43 pm
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coaster
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This is what I've done so far:

Case 1: effect of inflation on $1000 held for ten years.

Case 2: borrow $1000 at 7% at pay back over ten years.

Case 3: opportunity cost of $1000 at 7% over ten years.

Payments/interest/compounding occur at end of year. Results are expressed in terms of net present value.

Case 1: inflating $1000 at 4% for ten years => future value = $1000, present value = $675.56

Case 2: borrow $1000 at 7%: ten yearly payments of $142.38 => future value = $1428.80, present value = $1154.83

Case 3: opportunity cost: $1000 bond at 7%: ten payments of $52.50 net of 25% tax plus $1000 at EOY 10 => future value = $1525, present value = $1109.39

(Interestingly, it doesn't make any difference using straight or declining amortization of the loan)

Conclusions? Does inflation affect personal debt? The present value cost of the debt is $154.83, whereas the present value cost of just holding the money is $324.44. Obviously, the cost of debt is reduced by inflation.

And opportunity cost? That's magnified by inflation: $1109.39 - $675.56 = $433.83 difference present value. But the bond's return after 10 years future value is just $44.76. So fixed-income return is also reduced by inflation.

~Tim~
Post Thu Aug 31, 2006 9:44 pm
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go2self
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Debt will always oustrip investment yield when using conventional repayment plans offerred by lenders. We just have to consider who offers and designs the plans and whom does it benefit.

However there are derivative repayment plans that lets you safely hedge debt to your advantage. I say and stress safely because you use your banking institution and at your discretion.

An example of non-conventional repayment plans one is the biweekly repayment plan touted by many. Not very effective but it does demonstrate the point.

Time is our most volatile resource that if not used immediately is lost instantly
Post Fri Sep 08, 2006 12:43 am
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Deen888
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quote:
However there are derivative repayment plans that lets you safely hedge debt to your advantage. I say and stress safely because you use your banking institution and at your discretion.

I try to cope with stress using cbd oil, in spite of the fact that I used to be rather skeptical about it all the time. Cbd oil perfectly suits vaping, the best effect can be riched due to top quality vaporizer and cookies vape pen battery.
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