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The Impact of Inflation on New Loan Originations

The Federal Reserve Board voted to raise its key interest rate for a third time this year and is foreseeing three additional rate hikes in 2018. The federal funds rate moved to 1.50 percent, and this marks the fifth rate increase since 2015. Even though unemployment is currently at a 17-year low and we are seeing steady economic growth, inflation remains stagnant. Consumer prices appear to have stalled, and we've even seen price drops in certain sectors over the past month. Whether inflation is low or high in the coming years, it could have an impact on new loan originations.

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How Inflation Impacts New Loan Originations

Inflation is the measure of changes in consumer prices over time, but how inflation impacts new loans depends on another factor as well - wages. As long as wages keep track with a rise in inflation, the purchasing power of a household will remain essentially the same. If wages fail to outpace inflation, which is our current situation, then consumers will have less purchasing power available and will borrow more to fulfill their needs.

Interest rates tend to rise during periods of inflation, which impacts both consumers and lenders. Consumers who have savings and CDs will earn more on their deposits, although these increases rarely keep track with inflation. Lenders can charge more for their loans, but they may also find that their delinquency rates go up if inflation continues to rise.

If the purchasing power of households keeps eroding, mortgage and auto loan payments could fall by the wayside.

Freddie Mac believes that inflation is going to continue rising "modestly" over the next several years, which is good news for future homebuyers who may be concerned about the affordability of real estate. The recent slowdown in multifamily construction could allow the short-supplied construction labor force to switch to single-family home projects. This would be a welcomed event for both builders and lenders because there is still unfulfilled demand in this market.

Another vital thing to consider is consumer expectations. If there is an expectation that inflation is going to soar, consumers will spend and borrow more money now in the belief that goods and services will be more expensive in the future. While we may not have that environment currently, there is always the chance that the economy will shift and create these conditions.

What Inflation Numbers Could We See in the Future?

According to the latest opinion from the Fed, we may not see inflation numbers reach that 2.0 percent target until as late as 2019. While past Fed predictions have been wrong, the current inflation forecast for 2017 is 1.7 percent, rising to 1.9 percent next year, and finally hitting that 2.0 percent target in 2019.

Outgoing Fed Chair Janet Yellen and other Fed officials believe that there are several factors at work keeping inflation down. First, the Fed may not be using the right figures to relate inflation and employment in our changing economy, meaning that unemployment may need to go even lower to drive up inflation. Second, the way that consumers shop has changed drastically, so this could also be holding prices down. For example, apparel prices in November dropped 1.3 percent, which was the biggest reduction since 1998. Consumers themselves are holding down prices by using technology to shop and get the best deals available.

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Optimize Loan Portfolio Returns By Partnering with an Asset Management Company

Inflation may prompt an increase in new loan originations as consumers battle to keep their purchasing power intact. Unfortunately, there may also be an uptick in delinquencies depending on the level of inflation over the next several years and the changes in interest rates.

Partnering with an asset management company that understands how to minimize risk and maximize returns helps ensure that lenders can keep the strongest portfolios possible. Buying loans from banks as well as selling loans that are characterized as non-performing assets is the best way to accomplish this goal.