How Does Inflation Affect Credit Card Debt?

Hearing about inflation can make anyone worried. With credit card payments, everyday needs, and the occasional treat, most people don’t have extra money for things to get more expensive. However, using a credit card to offset these price increases can lead to trouble.

While you might be tempted to spend more on your credit card to keep up with the cost of living, if you’re not earning more money to make up the difference, your debt can quickly start piling up.

Let’s take a look at how inflation and credit card debt are linked and what steps you can take to handle it. We’ll talk about everything from how interest rates affect your debt to ways you can cut back on spending.

What is inflation?

Over time, the prices of things we buy every day, like food, clothes, and gas, tend to increase. This is known as inflation.

Inflation happens for various reasons, like an increase in wages, prices of raw materials, taxes, or the money supply, but it mainly means that your money doesn’t go as far as it used to. For example, if a loaf of bread cost $2 last year and inflation goes up by 5%, that same loaf might cost $2.10 now.

This price increase affects everything, not just the bread. When the prices increase, but your income stays the same, you lose purchasing power. It means that without getting more money in your pocket, you’ll be able to buy less with what you have. This situation is what we call the economic impact of inflation. It can make it harder for people to save money or pay off debts because they have to spend more on basic needs.

Another important term is stagflation. Stagflation happens when there’s a period of quickly rising prices but low or negative economic growth and high unemployment. The inflation rate often outpaces growth. Although rare, stagflation can occur, and there have been occurrences in the past.

What determines inflation?

The Consumer Price Index (CPI) is the most popular way to keep an eye on inflation. It looks at how the prices of a group of everyday items change over time. These items include things like food, housing, household expenses, transportation, medical care, clothes, and even alcohol. This index is updated every month to show new changes.

Some items’ prices can fluctuate significantly, making the overall picture a bit fuzzy. That’s why there’s something called core inflation. Core inflation helps filter out those fluctuations, giving a clearer view of the trend.

The CPI is extremely useful for many people. Policymakers use it to decide on interest rates, which can affect loans and savings. Employers might use it to determine if they should increase wages, and governments can use it to adjust taxes and benefits like social security, ensuring they keep up with how much living costs are going up.

How does the central bank control inflation?

The Bank of Canada (BoC) changes its main interest rate to help control inflation in Canada. This interest rate helps guide how money is managed in the country, aiming to keep inflation close to 2%. The BoC might raise this rate when the economy is doing really well. This makes it more expensive to borrow money, which can slow down how much people spend and borrow.

On the other hand, if the economy needs a boost, the BoC might lower the interest rate. This makes borrowing cheaper, encouraging people to spend more while boosting the economy.

How rising prices influence credit card debt

As things get more expensive, you might use your credit card more and end up with more debt if you’re not careful. Imagine every time you go to the store, things cost a little more than before. Now, think about using a credit card to buy those things. If you’re buying more expensive items with the same card, you’re going to end up owing more money on that card.

When prices rise because of inflation, you might not always have enough cash to cover it. So, you use your credit card more. But if you can’t pay off that card right away, the amount you owe grows over time, especially with the credit card interest you incur daily based on your credit card’s balance.

How inflation is connected to your APR

Consider your credit card’s interest rates as the cost of borrowing money. Your APR, or Annual Percentage Rate, is basically what it costs to use your credit card over the course of a year. When prices go up everywhere, the interest rates can go up, too.

If inflation is high, the people who control interest rates might raise them to try and slow down how much money is being spent. When the interest rates go up, your credit card company might also increase your credit card’s APR, as credit card companies can change interest rates on credit cards at any point as long as they provide notice. That means if you carry a balance on your card, the interest you owe will also increase.

So, you’re not just paying more for things because of inflation; you’re also getting hit with higher costs for any money you’ve borrowed on your credit card.

Higher credit card interest rates mean it costs you even more money to get rid of your credit card debt. Let’s assume you have a credit card balance of $5,000, and the interest rate increases from 18% to 28%. That increases your incurred monthly interest from $75 to $116.67.

How does inflation impact your wallet?

When everything starts costing more, you’ll notice your money doesn’t go as far as it used to. This means you have to be more careful about how you spend your money. Food is one of the most common items impacted. For example, a $5 block of butter may now cost you $6.50. Other items affected by inflation typically include fuel oil, airfare, and eating at restaurants.

Look closely at what you’re buying and figure out what’s necessary and what can wait. Start by tracking where your money goes each month. See if there are things you’re spending on that you don’t really need or could find cheaper alternatives for. Maybe cancel some subscriptions you don’t watch much or cook at home more often instead of ordering out.

How does inflation impact your credit?

Inflation doesn’t directly impact your credit score. However, when high inflation makes everything cost more, you might end up using your credit card more often. Canadians may struggle to pay higher bills as prices rise. If you don’t have enough cash or available credit, you might quickly find yourself in even more credit card debt as you borrow more money to pay for everything.

Credit utilization rate is one of the factors used to determine your credit score, so your score may decrease if you spend too much time on your credit cards.

Plus, when inflation creates higher prices, it can also make it tougher to pay off any money you owe on credit cards or loans since the interest you’re charged can go up, too. Every time you make a late payment or only pay the minimum on your credit card, it gets reported. If this often happens, it shows you might not be great at managing your debt. This could lower your credit score, making it tougher to get approved for new loans or credit cards in the future, which lenders look at when deciding if they should lend you money.

Does inflation make borrowing money more expensive?

With increased interest due to inflation, if you try to get a new credit card or a personal loan, you might find it’s more expensive to borrow money than before, and you might not be able to afford it.

When inflation is high, interest rates on loans can go up. Financial institutions usually adjust their main interest rates based on what the Bank of Canada does. Raising interest rates can increase interest rates on loans and credit cards, making borrowing more expensive. So, if you’re thinking about making a big purchase or you’ve spent too much on your credit card, be ready to pay more in interest on the money you owe.

What’s the best way to manage your debts when inflation is high?

When things get more expensive because of inflation, you might find yourself using your credit card more often. But there’s a smart way to handle this so you don’t end up drowning in debt. Here are some tips to manage your credit card debt, even when prices keep going up:

Prioritize debt payments

Focusing on paying off debts that have higher interest rates first can help you save money on interest. Make sure you’re at least paying the minimum amount due so the credit card company doesn’t add extra interest charges to what you already owe.

Pay debts on time

Paying off your debt on time is an easy way to keep your finances in order and avoid problems. You won’t have to pay extra interest if you pay off what you owe on your credit card before the due date. If you have more than one credit card balance, keep an eye on how much you owe on each one and when you need to pay it back.

Consolidate debts

Debt consolidation is when you get one big loan to pay off several smaller debts and loans. It’s much simpler to keep an eye on one loan and one interest rate rather than juggling multiple credit card bills and different rates. If you can get a consolidation loan with a lower interest rate than what you’re currently paying on your credit cards, it could save you money on borrowing costs.

Using a balance transfer credit card is one way to consolidate your debts. This means you move all your credit card balances to one card, so you only have to pay interest on one balance instead of many. Doing this might help you improve your credit score and pay less interest over time. But, if you keep transferring balances to new cards too often, it could actually harm your credit score. It’s crucial to figure out the best way to reduce your debts and make sure you keep up with your payments.

Maximize credit card rewards

Many credit cards give you rewards that can help you save money or get cool perks, like getting cash back on what you spend or earning bonuses on things like groceries. It’s a good idea to look at different credit cards to see which ones match what you need.

Some credit cards offer special deals for a short time where you can get even more rewards, whether you’re a new customer or you’ve been with them for a while. Even though these rewards might not completely make up for the rising costs due to inflation, they can help lower your bills a bit, allowing you to use the money you save for other things you need to buy.

Review your credit score

Checking your credit report often is key because banks and lenders look at this report to decide if they can give you a loan or credit. They also use your credit score to figure out how much interest you’ll pay when you borrow money. The FICO score is a widely used type of credit score. You can usually get your credit score for free, so it’s a good idea to keep an eye on it to stay on top of your financial health.

Manage credit card debt more efficiently during inflation with KOHO

While a scary word to hear, there are pros and cons of inflation. The important thing is to learn about average credit card debt and make smart decisions for your own situation. KOHO can be a big help during tough times by encouraging good financial habits. Whether you want to build your credit with KOHO or earn interest and cashback rewards, KOHO offers tools to help you manage your money better when prices are going up.

The virtual credit card has guaranteed approval and makes it simple to make new purchases, manage your money, and keep your debt in check. You also get overdraft protection coverage, allowing you to use your cash advance to pay for unexpected expenses like car repairs. And when you pay back the cash advance by the set date, KOHO won’t charge you any interest, leaving you more money to spend on important things.

Take control of your finances and manage inflation responsibly with KOHO. Discover the features and benefits that provide you with the essential tools and knowledge to improve your financial health.