"Why Stocks Still Rock,
Bonds Will Bomb, and Cash Is King"
On July 23, 2002, I warned against investing right now in bonds and real estate. Today, a warning against investing in bonds appeared in the latest (December, 2002) issue of Money magazine ("Why Stocks Still Rock, Bonds Will Bomb, and Cash Is King"). In an article on page 84, "Game Plan", by Nick Pachetti, the magazine gives "Reasons to Beware Bonds". The reasons? the ones I gave on July 23rd: interest rates have much more "upside potential" than "downside potential", and the big surge in bond-buying, driving down interest rates as people jumped from the stock market frying pan into the "bond-fire". The article explains that many investors who have bought into bonds are taking the risk of being "whip-sawed" by two bad investments in a row.
A wealth of information is available at www.bankrate.com. .
The Money magazine article also discusses home ownership, with some interesting observations.
Refinancing your home at a lower interest rate
Money magazine gives the following example (on page 124):
Suppose you had taken out a 30-year, $175,000 home loan in December, 1996, at 6.63%, and you now want to refinance at 5.75%. Your current monthly payments are about $967. Would that be a shrewd move?
By now, after six years, you would still owe $162,000 on the principal, and you would have paid $68,000 in interest. You would have 24 years to go until you paid off the mortgage.
Closing costs would typically be $3,000 to $5,000. Your monthly payments would then be $776. At that rate, it would only take 17 to 28 months to make up the costs of refinancing. But....
If you refinance with a 30-year mortgage, it will now be 36 years from the time you started until you pay off your loan. That $68,000 in interest you paid on your original loan will have been lost. Your total interest costs on the old mortgage would have been $228,604. The total interest cost on the new loan would be $178,339. However, you've already paid $68,000 in interest, so you'd end up paying $17,753 in additional interest on top of the $3,000 to $5,000 in closing costs.
Their suggestion: raise your payments by $95 a month, bringing them to $871 a month, or about $94 a month less than your original payments. This extra money goes straight into principal, and, in effect, reduces the term of the loan to about 24 years.
An even better approach could be to take out a 20-year loan, taking advantage of the face that the lower interest rate would lead to lower payments. Beyond that, interest rates on 20-year loans are even lower than they are on 30-year loans. In addition, six years of modest inflation should have boosted your income by 15%-to-20%, improving your ability to pay.
Bottom Line: Refinance if you're willing to keep your house payments at or above their present level.
The article also describes "cash-out" refinancing, which can pull more money out of a home loan than the amount of principal that you've actually paid ($13,000 in our example above)... e. g., to pay college tuition costs. However, the article warns that if your loan amount exceeds about 80% of your home's value, you'll be "forced to pay costly private mortgage insurance".
Should I negotiate a shorter-term mortgage, or should I add a fixed amount to my monthly payments?
A shorter-term mortgage comes with lower interest rates, so it's probably better to negotiate a shorter-term mortgage.
Would an adjustable-rate mortgage (ARM) be the better choice?
The magazine points out that adjustable-rate mortgages (ARMs) give lower rates during the first few years, when the interest rate is guaranteed. After that, interest rates on ARMs can rise. However, interest increases are generally capped at 2%. If the initial interest rate on your ARM is 1% less than the interest rate on the equivalent fixed-rate mortgage, your interest rate might rise, for example, 1% above the rate of the equivalent fixed-income loan. If you're expecting to move within five years, an ARM would make good sense, since you'll be refinancing somewhere else, anyway.
It would seem as though it would make the best fiscal sense to use an ARM when interest rates are near their peaks, and are more apt to fall over the low-interest grace period than they are to rise. You'll end up paying a higher interest rate than you would if you refinanced, but that would be the case if you'd financed with a fixed-rate mortgage, anyway, and you'd have a lower interest rate with your ARM than you would if you had used a fixed-rate mortgage.
To be continued.