Inflation is a topic that often generates a lot of discussion, especially when it comes to financial planning. The effects of inflation can significantly impact your financial health, particularly in how you manage loans and savings.
Recently, a question was posted in a forum about whether to use a Ksh 500,000 lump sum to pay off a bank loan or deposit it into a SACCO savings account. While many responses encouraged the individual to pay off the loan and deposit the remainder into the SACCO, an important factor overlooked in this advice is the role of inflation.
This blog post aims to shed light on how inflation can affect your decisions regarding loans and savings in Kenya.
Understanding Inflation
Inflation is the rate at which the general level of prices for goods and services is rising and subsequently, purchasing power is falling. As of April 2023, the annual inflation rate in Kenya stands at 7.9%¹.
This means that your money loses around 7.9% of its value if it stays liquidated for the whole year. Therefore, understanding inflation is crucial when making decisions about your money.
Inflation and Loans
Contrary to what one might think, inflation can actually be favorable for those with loans, provided that the loan terms are sensible and the interest rates are normal. For instance, if you secure a Ksh 500,000 loan with a bank at an interest rate below 15%, and you use this money to produce real value, such as investing in a business, you can effectively increase your net worth. The current average loan interest rate in Kenya is approximately 13.06, which is below the 15% threshold.
Here's why inflation is beneficial to loan seekers: the value of money decreases over time due to inflation. Thus, when you repay a loan after a few years, you're repaying it with money that has less purchasing power. This essentially means that you're paying back less in terms of value.
Inflation and Savings
On the other hand, inflation has a different impact on savings. With the current inflation rate at 7.9%, if you put your money into a savings account that earns an interest rate of, say, 5% per year, your net gain would not be sufficient to offset the effect of inflation. The average savings account interest rate in Kenya is between 4% and 6%, which is lower than the inflation rate. This means that the value of your savings is essentially decreasing over time, as the purchasing power of the money in the savings account diminishes.
Final Thoughts
Inflation is an important factor to consider when deciding between paying off a loan or putting money into a savings account. While inflation may decrease the real value of your savings, it can actually benefit those with loans. Consequently, understanding how inflation interacts with your loans and savings can help you make sound financial decisions.Remember that these principles apply when dealing with reasonable interest rates and sensible loan terms. Loans with exorbitant interest rates, such as some mobile loans, are a different matter entirely and should be approached with caution.
Finally, it's important to remember that this is a general guide and individual financial circumstances can vary greatly. Always consider seeking professional financial advice when making major financial decisions.
References
1. "Kenya Inflation Rate - April 2023 Data - 2005-2022 Historical - May ..." Trading Economics, www.tradingeconomics.com/kenya/inflation-cpi. Accessed 15 May 2023.2. "Kenya Bank Lending Rate - April 2023 Data - 1971-2022 Historical - May ..." Trading Economics, www.tradingeconomics.com/kenya/bank-lending-rate. Accessed 15 May 2023.
3. "Money254 | Kenya’s Top Savings Accounts." Money254, www.money254.co.ke/savings-accounts. Accessed 15 May 2023.
Last edited by a moderator:
