Say for example a person gets a home loan of $100,000 in a certain country at an interest rate of 10%. Inflation is normally around 5% in this country.

What could happen to that person's loan if the country's inflation rises to say 1000%?


Complementing @FooBar 's answer, a more and more usual contractual arrangement observed is for the debt principal to not be indexed to inflation, but for the contractual (nominal) interest rate of the loan to be "variable", something like "base + premium". In such a case, nominal interest rates will adjust to inflation, and so the loan repayments will increase to a degree from that channel, although the nominal value of the debt principal will not change.

Finally, another contractual arrangement, seen in countries with weaker economies, is to have the debt indexed to an exchange rate, usually of one of the "international currencies". The "lure" for borrowers is that in such a case the interest rate is lower to what it would be otherwise. The risk is that if the exchange rate deteriorates (which will happen in high inflation cases), they will see the nominal value of their debt jump (while their income does not necessarily follow suit).


If the loan is indexed to inflation, "nothing" would happen. The remaining loan payments would simply increase.

If the loan is not indexed to inflation, when inflation occurs, the debtor's wage would most likely increase with the inflation rate. Hence, he would very quickly have the money (in nominal terms) required to pay back the debt (which is now less worth, in real terms).

Consider the loan $L$ in monetary terms, and denote the price level by $P$. The lender was expecting $L/P$ when he formulated $L$. Now, instead, he is getting $L/P_2$ in real terms, which is (for the much larger price level $P_2$) a much smaller real value.

Which leads us to the conclusion that in this case (and very often), higher inflation is a redistribution from lenders to debtors.


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