Motley Fool guest contributor Brad Hessel manages an investment advising service in North Carolina. He has previously worked in investment banking, and has founded or co-founded a computer game design company, a CASE tool software company, and a knowledge management consulting practice.
You should refinance. Now!
Many observers are bemused by U.S. policy. Faced with a financial crisis caused by the bursting of an out-of-control residential real estate bubble -- engendered and nurtured by the government's generous lending standards and engineering of loose money and low interest rates -- the response has been to fight fire with fire: still lower interest rates, still looser money, and tax incentives to encourage the citizenry to borrow still more money for houses, cars, etc.
On a macroeconomic level, this response may be hard to fathom, but one thing is perfectly clear: The U.S. government -- the largest debtor in the history of humankind -- is engineering conditions that are extremely favorable to debtors. Interest rates on debt are low, and the value of the dollar is shrinking fast, which means any dollar-denominated debt burden is decreasing daily. Thus, if you own a home, these are perfect-storm conditions for refinancing -- great for borrowers.
But for lenders such as Citigroup (NYSE: C ) , Bank of America (NYSE: BAC ) , Wells Fargo (NYSE: WFC ) , and HSBC (NYSE: HBC ) -- plus, indirectly, Fannie Mae (NYSE: FNM ) and Freddie Mac (NYSE: FRE ) ... not so much.
First of all, as is common knowledge, rates are at historic lows, dipping below 5% on a fixed 30-year mortgage. If you have a mortgage in the 6%-to-6.5% range or higher --which is likely unless you've already refinanced in 2009 -- this is a no-brainer. Even with a point to point-and-a-half of closing costs, you'll probably end up paying out fewer dollars over the life of the new loan than you have left to pay on your current loan. You will certainly pay less per month. Check out the Fool's section on refinancing and analyze your situation using a mortgage calculator such as this one.
But wait, there's more! If the dollar continues to depreciate (it's depreciated at a compound annual rate of 4% since 2002) due to our increasing national debt, any resulting inflation is to your advantage. This is because even if inflation caused by the dollar's decline drives up the nominal cost of food and energy (and hopefully your salary), your new mortgage payment is fixed, in nominal dollar terms, for the next 30 years. (With rates having nowhere to go but up from here, eschew adjustable-rate mortgages.)
Indeed, if you are confident you can earn, say, a nominal 8% return on any funds you manage (a big "if" but consistent with long-term historical average market returns) AND you have a high enough risk tolerance, then you could consider borrowing more money than you need to pay off your old mortgage and investing the balance ... presuming your credit rating and real-estate valuation are strong enough to enable you to do so.
The same principle applies if you have any personal debt at a higher rate of interest, most especially if that higher rate of interest is not fixed, as with credit card debt. As general interest rates rise, the rates you pay on such debt will most assuredly rise along with them. Therefore, if you have an opportunity to convert that variable-rate debt into 5% fixed-rate debt -- by refinancing with a larger loan than you need to retire your existing mortgage and using the cash to pay down the personal loans -- you should take advantage of today's perfect-storm refinancing conditions.
Finally, if you're 62 or older and considering a reverse mortgage, you should look closely at the fixed-rate version of the increasingly popular loan. It's true that fixed reverse mortgages typically require you to accept a lump-sum up-front payment and therefore aren't as flexible as variable-rate lines of credit. But in an environment with rising interest rates, the amount of interest charged against your loan balance as you receive money from a variable-rate reverse mortgage will rise relentlessly over time. So on balance, a fixed-rate reverse mortgage may be the better choice.
Our recent brush with systemic risk has led us to an unusual investing climate, with increased volatility and risk both for organizations and individuals. Nevertheless, in such extreme circumstances, a careful analysis of macroeconomic and political trends can reveal opportunities, as well. In January, PIMCO guru Mohamed El-Erian famously advised investors to "position their portfolios predominantly under the umbrella of government support rather than outside it." Now the government has extended support to borrowers -- especially itself -- and the macros are telling us it is time to bring your debt under the umbrella, too.
What are your thoughts on refinancing and the direction of interest rates? Let us know in the comments area below.