The worst of the Covid-19 pandemic in the United States appears to be over. But the economic fallout will continue for some time. Inflation and rising interest rates are two of its legacies, and they can both undermine the financial security of individuals and families. Budgeting wisely in this environment is crucial to riding it out successfully.
Take the biggest elephant in the room: inflation. After limping along at about 2% a year from 2000 to 2020, inflation recently jumped to 7.5%, its highest level in 40 years. Even at a modest 2%, inflation can cause a lot of damage. A dollar today is worth only about 60 cents of a dollar in 2000.
People in this environment need to take a close look at their spending. One crucial aspect of this is their debt payments. Inflation actually helps people in debt - it erodes the value of a loan. If you took out a fixed-rate mortgage in 2000, and you pay $1,000 a month, that payment is worth only about $600 of its original value.
So consider your fixed-rate debts, especially your mortgage and student loans. If you pay more than your contractual monthly payments, it is time to stop. Seven-percent-plus inflation will reduce the value of these debts more than your extra payments could, and will do it for free. Look instead to your floating-rate debt - credit cards and home equity lines of credit (HELOCs), for example. These could cause trouble, and should be your priority.
That's because, to fight inflation, the U.S. Federal Reserve is about to start raising short-term interest rates. That means the rate on your credit card debt is likely to rise, and at a faster clip than your balance will fall in value due to inflation.
Redirect any extra money you might be using to pay down your mortgage or student loans toward reducing your credit card debt instead. (Keep making the required payments, of course.) It could save a person with $5,000 of credit card debt at a 20% interest rate upwards of $1,000 a year.
You should also consider the timing of any purchase of so-called “consumer durables” - cars, appliances, and so on. Normally, when inflation spikes, it’s wise to make these purchases as soon as possible, before prices rise too much. But the pandemic has messed up this calculation by disrupting supply chains, which has made many of these items, especially cars, exceedingly expensive almost overnight, as the following graph from Wolfstreet.com shows.
New car supplies have been hamstrung by a lack of computer chips, and used car supplies by the fact that car rental agencies - the main source of used cars - scaled back their purchases, and subsequent sales, way back. Luckily, most people can usually get another year out of their existing clunker if need be. In this environment, that’s probably a good idea - when supplies get back to normal, prices should come down.
Other big-ticket items are a harder call. Many of them are also shooting up in price due to supply chain snafus. If you are forced to buy a big-ticket item, say your water heater or fridge gives up the ghost, you will have to pay the going rate. But for those people who can defer a purchase, it might be best to take the same approach as with a car, and hold off until the supply chain problems are solved and prices come down.
Taking a few simple precautions like this won’t eliminate hardships from inflation and rising rates, but it could make them less painful.