When it comes to debt, there are three kinds of people in America.
- The debt-free. They receive interest on their savings. This is a small group.
- The debt-ridden. They pay interest on their debts and receive no interest because they have no savings. This is a large group.
- The in-betweens. These are are people who pay interest on some debts and receive interest on some savings. This is also a large group. Their eventual goal is to have net interest income— to have the interest income they receive exceed the interest they pay.
Today, the first two groups are stressed. Those who are debt-free struggle because a major source of income is disappearing as yields decline. The debt-ridden struggle because it’s hard to pay down debt when your income from labor is in danger or shrinking.
But the people in between have a major opportunity. It’s called refinancing. The largest single opportunity is in refinancing home mortgages. Since we’ve had three decades of mortgage refinancing most people already know this. What you may not know is how powerful it is compared to all the alternatives.
Refinancing isn’t easy. It requires a lot of paperwork. But the end result can save you far more money than you’d earn on any interest bearing investment. Indeed, a case can be made that refinancing is a better move than investing in the stock market, with far less risk.
Here’s an example. George and Sally Mugwump live in a $250,000 house that they bought many years ago. The mortgage balance is $150,000 at a rate of 5.5 percent. This year they expect to pay about $8,250 in mortgage interest. Unlike most Americans, they have no credit card debt and they own their cars free and clear. They make regular investments in their company 401(k) plans and they have an emergency cash account with $10,000 in it. They would like it to grow.
Frustrated by a savings account yield of less than 1 percent at a major bank, they moved their money to a bank offering the Reward Checking I wrote about last week. Now they earn 4 percent on their emergency cash account. Since they will earn $400 a year on their emergency cash account, their net interest expense is down to $7,850.
They would like to do better, but don’t know how, or where, to invest the money.
Their best bet is a “refi” of their home mortgage. A refi that brought their interest rate down to 4.5 percent— easily done in the current market— would cut their interest expense by $1,500 a year. (It would also reduce their monthly payment, but that’s another story.) If the cost of getting the mortgage refinanced is 2 percent of the mortgage value, or $3,000, it will take only 2 years to recover their “investment.”
Over a period of 10 years they would save $15,000 in interest charges. That’s 5 times their initial “investment.”
Can any other use of their money come close?
Not likely.
It is possible that the stock market will double over the next 10 years. Don’t laugh. But there are also rumors of pigs learning to fly. Even if stocks doubled in value, the gain would be far less than rising to 5 times its current value.
To achieve the same interest income as their $1,500 a year savings, the Mugwumps would need to invest $150,000 in a CD yielding 1 percent or $75,000 in a CD yielding 2 percent. Even if they could earn 4 percent— the rate on their Reward Checking and a bit more than the yield on a 30 year Treasury— they would need to have $37,500.
So the productivity of refinancing is vast. About $3,000 of expense will produce benefits that would require 10 times to 50 times as much as money invested in other ways.
Should you refinance?
Answer: Yes, if you can do it at low cost and the “payback” is fast. Even if you would need to pay down the principal to get the mortgage done, a refi is likely to be worth the effort. After all, where can you get the 5 percent plus or so you’ll save on the paydown AND get a quick payback on your refi costs?
On the web:
Get Paid to Move Your Money (10/01/2010)
http://assetbuilder.com/blogs/scott_burns/archive/2010/10/01/get-paid-to-move-your-money.aspx
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
(c) A. M. Universal, 2010