Being a debtor isn’t necessarily one of the most pleasant labels you would want to be associated with. However, if you look at pure economic terms, then being a debtor means you are always getting more than you asked for. You may not realize how the state of your economy helps you when you take out a loan. Today, we will talk about a concept that will blow your mind and make you look at debt in a much different way.
Inflation- the hidden factor behind a good loan
To understand it simply, inflation is the gradual increase in the price of goods and services over a period of time. For example, a burger that costs you $1 today, could cost you $1.40 the next year. This means that you will be paying more for the same product or service. You can also understand it another way. If $1 gets you one burger today, $1.40 should get you 1 + 40% of the second burger. However, an year from now, you will be getting only one burger instead of 1 + 40%. This shows that the prices of goods and services will appreciate over time.
So how does inflation and lending coincide with each other? Inflation affects your currency. A $1 note can buy much more today than it can buy tomorrow. When a lender like Payday Pixie offers you a loan, they are giving you a higher value in lieu of a smaller value tomorrow. This is the reason a lender charges an interest from you. They are not just compensating for parting with their money but also charging you because they let go of their current satiation to get a higher sum of money from you tomorrow.
Let’s understand how this work. The rate of inflation is 2% in a country. This means that everything that could be bought for $100 today will cost $102 the next year. When you return the hundred dollars next year, the purchasing power of value of that money will fall to $98 i.e. 2% depreciation in value. Essentially, the lender is giving you $100 to get the value of $98 back, when in reality he should be getting $102 to get the same value back.
The lender, therefore, imposes a annual rate of interest to get the $102 back. He puts an interest rate of 4% on your original $100 loan. Because of this, he gets $104 back. $102 returns the value of his loan back to him while $2 becomes a compensation for his lending.
When you believe that you are paying a high 4% interest on your loans, you are actually paying 4%- 2% (or whatever the current rate of inflation) to the lender. In our example, the lender is only paying a 2% interest.
Did you understand the math? It is very simple and easy. If you have any existing loans, calculate the effective rate of interest you have paid by deducting the rate of inflation. You will be surprised at the results.