How does inflation affect credit card debt?

Inflation is a scary word that we often hear on news and business channels. Credit card debt is another very scary word (or three) that hits a bit closer to home. It turns out, however, that the two are intricately linked. Rising inflation can have a drastic effect on any type of revolving or floating interest rate because those rates will likely rise.

Let’s take a look at exactly how inflation can affect credit card debt, a few of the other products that can be affected, and how you can avoid falling victim to inflation-related trouble with your credit cards.

How does inflation work?

Put simply, inflation reduces the purchasing power of a given currency. This is reflected as a general increase in the price of goods, combined with more money being present in a given economy. Have you noticed over the last several weeks that some fairly normal items have gotten more expensive? That’s inflation. Supply constraints, combined with quite a lot of money flowing around the economy have made the buying power of a dollar far less.

The Bank of Canada is able to control inflation by increasing and decreasing the prime interest rate, which is the rate at which banks lend to each other when they reconcile payments and receipts overnight. The Bank has maintained a low interest rate during the pandemic and has only recently started increasing this rate which now stands at .5%.

This is in stark contrast to deflation, which occurs when the value of money goes up but the price of goods goes down. On its face, this sounds like a good thing but generally, the supply of money will decrease sharply with deflation, making things difficult for most consumers.

So what does that mean for credit card debt?

So we know that inflation lowers the buying power of a single dollar. What does that mean for credit card debt? It may seem like this is a net positive. Let’s say you buy a basket of lemons for $10 on your credit card today. You stop by the store the next day and that bag of lemons is $12; you’ve locked in the price at $10 right? Nice! While this is true, you used your credit card to make the purchase and perhaps, haven’t considered the fact that you have to pay interest on that amount if you don’t pay off the full balance. This is where inflation can get tricky.

Credit card interest rates, like most other variable rate products, are pinned to the Bank of Canada’s interest rate and inflation. This means that as inflation takes hold and things get more expensive, your interest rate may increase. Additionally, when the Bank of Canada changes its interest rate in an attempt to control inflation, your rate may increase along with it. Both of these things make that bag of lemons you purchased more expensive over the long term.

They can do this anytime?!

Yes and no. Credit card companies are permitted to change your interest rate whenever they like, but they have to give you notice that they are doing so. This can give you some time to plan but if you’re deep in credit card debt, it may not be that helpful to you.

Are there other times interest rates can change?

Sure are. Credit card companies often use promotional rates to entice new customers to get accounts. These often range from 0-5% on new purchases and can be incredibly helpful if used correctly. Additionally, your interest rate can fluctuate if you don’t pay your bill on time. Interest rates are, more than anything else, a reflection of the company's willingness to risk you not paying your debt. This means that if you stop or are late paying your bill, that risk will increase, thus higher interest.

So what can you do?

This can be a little scary to think about. All of a sudden, you’re minding your business and your credit card rates shoot up, making things suddenly a lot more expensive to purchase. There are a few things that you can do, however, to reduce this shock.

Don’t use credit

We’re in a period of economic history where rates are almost assuredly going to go up. Inflation is already here and continues to climb. If you find that paying your credit card bills or making ends meet is tough, it might be time to get out of the credit card game altogether. Well, maybe not all together but moving to a place where you’re almost or completely paying off the bill before the end of the month. This will help you stay out of the reach of interest charges and avoid unnecessary payments.

Get out of debt

If you’re already in debt, get out as quickly as possible. Being in credit card debt is never a good thing but during an inflationary period, it is far worse. The first step here is to ensure your budget is solid. Understand inflows and outflows, and make sure you have a firm grasp of the amount you can contribute to your debt each month. You may find you have to cancel that ski trip or cut back on drinks with friends for a time—anything you need to do to get out of debt.

Next, sort out the strategy that works best for you. If you’ve got a single credit card, throw as much as possible at the balance. If you have decent credit, you could also consider a balance transfer to a more responsible rate. Note, that you’ll have to pay a fee for this service and, of course, you’re still in debt! If you’ve got multiple accounts and can’t get them transferred, consider either the avalanche or snowball method. In the former, list your debts by interest rate. Then, make the minimum payments on all the bills, but throw any extra money at the balance with the highest interest rate first. When it is completely paid off, roll all the money to the next highest interest-rate balance and work your way down. In the snowball method, list your debts by balance, make the minimum payments on all of them and toss all of your additional money at the lowest balance.

Both systems work well to reduce credit card debt and either one will get you out of debt if you stick to it. Whether you use one or the other is your personal preference.

Inflation and credit card debt don’t mix

Like oil and water my friends. While it may seem that you’re getting one over on the credit card company by getting something cheaper, in reality, you’ll end up paying more if you have a balance and rates increase or inflation continues. As with all things, budget is the key here. You should never be in a position where you have to rely on credit cards to make ends meet each month. If you find you are, it may be time to cut expenses or seek alternate employment to bring in more cash.