What is lifestyle inflation — and is it really that bad?

The Mint app has shut down as of Jan. 1, 2024. For alternatives, check out CNBC Select's ranking of the best budgeting apps.

Increasing your income is one of the best ways to help you reach your financial goals, whether they include paying off your debt, investing, saving for retirement — or all of the above. However, a higher income sometimes invites lifestyle creep, turning those extra dollars into higher spending.

At the same time, what's the point of a higher income that doesn't improve your quality of life? It's important to plan for your future, but you should also balance those plans against enjoying your wealth right now. Below, CNBC Select offers advice on how to avoid lifestyle inflation without succumbing to the scarcity mindset — and how to raise your standard of living while staying on track with your long-term goals.

Lifestyle creep happens when your spending on non-essentials increases, which can sometimes be dangerous to your financial health. Having room in your budget makes you want to fill it — with a pricier living space, a newer car, more frequent restaurant trips — and the list goes on.

"Internally, [you] are feeling a need to buy something at a higher price point than you would have in the past," says Manisha Thakor, financial wellbeing expert and author of 'MoneyZen: The Secret to Finding Your "Enough'.

Typically, lifestyle inflation happens when you get a boost to your income or a rise in short-term investment returns. However, it can also appear if you're prone to comparing yourself to others. Let's say, you're following your colleague on social media and see them travel to Europe twice a year and drive a luxury car. You may begin to wonder why you're not doing the same.

At the same time, if you can't enjoy the fruits of your labor, you may lose sight of your money's purpose. "We want to experience things as we go through life, not as we look back on our life," says Bobbi Rebbel, CFP and author of 'Launching Financial Grownups'. "I do think that if you are responsible and create a sustainable budget, it is okay to upgrade your lifestyle. A scarcity mindset is never going to allow you to live your best life!"

The scarcity mindset can lead you to believe you never have enough money, which results in hoarding your wealth. Fortunately, you don't have to choose between living an unsustainable lifestyle and becoming a miser. Learn to recognize the warning signs of lifestyle inflation, and you'll be able to enjoy the good life without getting in over your head.

There's a fine line between responsibly enjoying your hard-earned money and falling prey to lifestyle inflation. Here are a few signs of the latter:

1. You have credit card debt

Sometimes, people fall on hard times and carry a credit card balance just to pay for necessities, like groceries and utilities. But if you notice you're consistently in credit card debt while still eating out multiple times a week or getting new sneakers each month, then you're probably participating in some lifestyle creep.

2. You get into risky long-term debt

If the only way you can afford the house you want is with a balloon payment mortgage (where your last payment on the mortgage needs to be much larger than your prior, regular payments) or an adjustable-rate mortgage (where the interest rate is constant at first but begins to fluctuate after a specified number of years), it's best to think twice. The temptation to get this kind of loan might be stemming from lifestyle creep.

While you may want to go with these types of mortgage loans in certain scenarios, they also come with a high level of risk. For example, if you take out a 7/1 adjustable-rate mortgage loan (meaning the interest rate can start changing after seven years), you're literally betting the house on being able to afford those adjusted payments after seven years.

But even a regular fixed expense can be risky if it's pushing your affordability limit. Say you're looking to rent an apartment and can comfortably afford a $1,700 monthly payment. But you have your eyes set on a place that will cost you $1,750 per month. That might not seem like much of a difference unless your financial situation changes for the worse — even slightly.

"If something were to create an income interruption or reduction, are you in a strong enough financial position to make the adjustments needed?" Rebbel says. "For example, it is easy to simply cut back on eating out. But if you have locked in a mortgage or rent that creates an ongoing cost that is going to be hard to lower — you may have a problem."

3. You spend to project a certain image

To avoid sinking too much money into items that are meant to signal your status, you need to distinguish between the desire for something that brings you joy and wanting something that shows how well you're doing.

For instance, if everyone in your office is wearing the new expensive smartwatch, you may begin to feel like you need the same one — even though you love your current watch and it serves you well. This is the lifestyle creep telling you to follow the trend. On the other hand, if you're a technology nerd and the features of the latest gadget genuinely fill you with excitement, the purchase can bring you true joy.

And remember: You don't know what is going on in the bank accounts of people giving you the lifestyle creep. An image is just that — an image. Thakor recalls that when she had her own wealth management firm, she once met with a prospective client who displayed all the expected status symbols of wealth — a luxury vehicle, designer clothes, etc. — but couldn't meet Thakor's minimum for investable assets. "She was drowning in debt," Thakor says. "She literally looked like a million bucks on the outside, but had nowhere near a million bucks."

If you start earning more and never adjust your lifestyle, putting everything toward saving and investing, you'll be safe from lifestyle inflation. And if you know you're extremely prone to it, that approach may be necessary.

Otherwise, you don't need to live in fear of overspending — you have the right to buy and enjoy things you work hard for. To do that and stay financially healthy, you need to take an honest look at your budget and set some "guardrails".

"The way I think about it is... You're driving down a steep and windy road," Thakor explains. "Oftentimes, there are guardrails on either side of the road to keep you from flipping over the edge." You can use the same framework for navigating your financial life and create protective barriers to stay safe from overspending.

Do the math

To know how much you can save and spend, you should create a budget. No need to spend hours on an Excel sheet (unless you're into that sort of thing) — you can use a simple budgeting app instead. CNBC Select recommends Mint, which you use for free, to connect all of your accounts and set up budgets and goals.

Once you see how much you spend on essentials and how much room you have left in your budget, you can set up your guardrails for debt management and for savings. Managing these two aspects of your finances will go a long way toward putting you on the path toward sustainable growth.

Manage your debt

If you have debt, you need a plan for managing it. You should always have space reserved in your monthly budget for your installment loans, from your mortgage to your car loan and student loans. Create a strategy for your credit card debt as well. You want to make at least the minimum payment each month, but the more you pay and the sooner you get rid of it, the better for your financial health. Ideally, you want to make a habit of never carrying a balance on your cards at all.

It may be helpful to apply for a balance transfer credit card. This way, you can move balances from your other cards and pay them without interest charges for the duration of the promotional period. For example, the Wells Fargo Reflect® Card, one of our top picks for balance transfer cards, offers 0% intro APR for 21 months from account opening on qualifying balance transfers (18.24%, 24.74% or 29.99% variable APR thereafter).

Save and invest

The next two important buckets in your budget are for saving and investing.

As far as savings go, you want to have an emergency fund — three to six months' worth of essential expenses saved in a high-yield savings account. The LendingClub High-Yield Savings is one of our favorites, thanks to its strong APY and few fees. Your emergency fund is your safety net, designed to help you weather financial storms such as loss of income or urgent expenses. It should be your priority before you begin to save on anything else.

After that, it can be a great idea to add a few other savings goals. If you're dreaming about a week-long vacation in Monaco, don't go into debt for it — make a savings goal. Thinking your living room could benefit from a new couch? That's another goal to put money toward.

While you're saving for your short-term wants and needs, don't neglect to invest in your future. Max out your retirement plan contributions, and if you're already on it, consider other investments as well. Investment apps like Betterment also allow you to automate your investing, making it even easier to stay on track.

Enjoy the rest

Once you've set the guardrails, you can enjoy the journey. The money you're not putting toward essentials, debt, savings and investments is yours to spend without fear.

"Sometimes, you might weave too close to savings in the sense that you're denying yourself the joy that you could afford to give yourself," Thakor says. Other times, you might find yourself indulging a little more than your income can afford.

In either situation, you'll know you need to balance your spending to return to the middle of the road. Don't beat yourself up and focus on getting back on course.

Lifestyle inflation is an easy trap to fall into, so don't be hard on yourself if you find yourself in its grip. At the same time, remember that extreme frugality doesn't have to be the answer. Know your priorities when it comes to spending money and learn to enjoy it without harming your financial situation. And finally, don't let other people dictate how you should live and what you should buy — let your budget and goals do that instead.

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