Imagine that you buy a house and take out a mortgage of NOK 3 million. Like most Norwegians, you have chosen a loan with a floating interest rate and a repayment period of 20 years. At the moment you take out the loan, NOK 3 million is a significant sum. But how does the situation change when price inflation increases sharply in the following years? Basically, you have fixed monthly payments. However, given that you have a floating interest rate, these payments may change over time, particularly in light of economic fluctuations. For example, if annual inflation of 5 percent occurs, overall purchasing power will decrease – meaning that for each pay packet, you get less for your money. Price growth and wages help However, in an economy characterized by high inflation, it is also common for wages to rise. This attempt to keep up with rising living costs can partially counteract the effect of reduced purchasing power. Inflation also affects interest rates. In Norway, for example, Norges Bank has adjusted the interest rate up 12 times since the autumn of 2021, in order to counteract a rise in prices that has in periods reached up to 8 per cent. Such an increase in the interest rate means that the floating interest rate on your mortgage also rises, which in turn increases the monthly expenses for the mortgage. Despite this increase in spending, inflation provides some form of comfort in another area: it reduces the real debt burden. This happens because price inflation gradually “eats up” the real value of your mortgage. It may not be entirely intuitive for most people, you tend to think that the loan has to be paid anyway – and it has to. Nevertheless, this is useful knowledge. Let’s look at this more concretely: Year 1: You owe NOK 3 million. This sum has a given purchasing power in this year. Year 10: After ten years of inflation, what you could originally buy for NOK 3 million will now cost significantly more. Thus, your debt of NOK 3 million feels less burdensome, because the money does not have the same purchasing power as it did before. In addition, your income has increased, which further helps to reduce the burden. A nominal illusion This situation illustrates a phenomenon that BI professor Gisle Natvig refers to as “nominal illusion” in DN. He believes that, especially in periods of high inflation, we tend to assess our financial situation based on the nominal values, i.e. the size of the loan in kroner and øre, without taking into account the impact of inflation on purchasing power. Because even if the debt looks unchanged on paper, the real burden in relation to purchasing power and income is reduced. This can lead to a misjudgment of the economic situation, because one overlooks how inflation changes the value of money over time. Can lead to bad financial choices By paying off the loan faster, borrowers use money that has more purchasing power now to reduce a debt that becomes less burdensome to carry over time. This can have several consequences: You can get less financial flexibility, and a lower overall wealth over time. When you pay extra on your loan now, you are using money that has its full value in today’s economy. So by paying more on the loan now, you can actually use more valuable money to pay off a debt that in reality becomes less valuable. Then you spend more of your current, valuable resources on a loan that would be easier to pay off in the future – with less valuable money. This can be a financially inefficient strategy, especially if you have other needs or investment opportunities for this money. Of course, it is never wrong to pay off your loan. Some will also think that it is irresponsible to use nominal illusion as a kind of excuse to, for example, drop installments (if you have that option). Regardless of how you are doing financially, the knowledge of how the mortgage becomes less valuable with high wage and price growth can be interesting. It is also a lesson to take into a tighter financial everyday life, where the decisions about how to spend our money are becoming increasingly complex.
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Your mortgage is shrinking completely by itself – Statement
