What Is Inflation and How Does It Impact My Credit?

Summary:

Inflation does not have a direct impact on your credit score. But if rising costs make you more likely to rely more on credit, there may be an indirect effect on your credit and financial health. You can help prepare for financial setbacks with a financial plan that includes preparing a budget and creating an emergency savings account.

In this article:

What is inflation?
How is inflation measured?
Consumer Price Index
How does inflation impact your credit?
How to prepare for inflation

Inflation is top of mind for many people. According to our Q2 2024 Consumer Pulse survey, 84% of Americans ranked inflation as a top 3 financial concern, five percentage points higher than a year ago. Inflation can have a direct, financial impact to households and can indirectly affect your credit. 

Here’s what inflation is, how it can impact your finances and credit and how to prepare for rising costs of goods:

What is inflation?

In a general sense, inflation is when the cost of goods and services rise over time. If inflation rises suddenly and your income has not risen as well by the same or a greater percentage, it can cause financial strain. This is especially true if the cost of important household goods you use frequently, like groceries and gas, has increased.

How is inflation measured?

The Federal Reserve and other government agencies uses multiple indexes to track inflation. Two prominent indices include the Consumer Price Index (CPI) and Personal Consumption Expenditures Price Index (PCE).

Consumer Price Index

There are multiple ways to measure changes in the costs of goods. One measure of inflation is the Consumer Price Index , which is produced by the U.S. Bureau of Labor Statistics. The CPI is a fixed basket of goods that the Bureau of Labor Statistics tracks price changes for each month. The basket has many categories, including food, fuel and household supplies. The CPI is a simple way to see how much the cost of goods are changing for consumers.

Personal Consumption Expenditures Price Index

Another measure of inflation is produced by the U.S. Bureau of Economic of Analysis (BEA). The Personal Consumption Expenditures Price Index tracks changes in the price of goods purchased by U.S. consumers, not just the price of a fixed basket of goods, like the CPI. One major difference between the CPI and the PCE is that the PCE accounts for potential substitutions if consumers have been priced out of a particular product. The BEA states this helps track consumer behavior and provides an example, “if the price of beef rises, shoppers may buy less beef and more chicken.” 

How does inflation impact your credit?

Inflation has no direct impact to your credit report or credit score, but you should be mindful of the effects inflation can have on your overall financial health, which, in turn, can affect your credit health. For example, if you use credit to pay for everyday purchases and have trouble paying down your balances in full each statement period, you could be in danger of missing a payment or carrying a high balance.

Late payments and your credit utilization rate are two important credit scoring factors. So if you routinely carry a balance on your credit cards or miss a payment, it may have a negative impact on your credit score.

How to prepare for inflation

As with any other financial setback, the normal rules of financial planning apply. Work toward building up a solid savings fund if you can. Having something, even if it’s a small amount, saved up for an emergency can help prevent you from having to use a credit card or loan which can have costly interest rates.  

If you haven’t done so recently, take a look at your budget to make sure you know exactly where your money is going and if there is anything you can cut that won’t have a major impact on your standard of living. Things like big household purchases, extended vacations or new cars may need to be delayed if grocery prices and other necessary goods continue to increase in price.

Creating a financial plan can help you wade through the tide of inflation. Practicing responsible financial habits can help you prepare for uncertain economic conditions and may limit any negative impact to your credit health. If you’re using your credit card more, read our blog post for tips on how to use it responsibly and build your credit history.