By: Gene Walden, Senior Finance Editor November 10, 2016
Earning a decent return on your savings may be particularly difficult in today’s low interest rate environment. However, it may be an ideal time for you to turn the tables and actually take advantage of the historically low rates by making some changes in your financial situation.
Here are 10 steps consumers may wish to consider to save money on their loans, lower their monthly payment burden, refocus their investment strategy, or improve their lifestyle or their business:
1. Refinance your mortgage
If you bought a home several years ago while interest rates were higher, you may be able to cut back significantly on your monthly mortgage payment by obtaining a new mortgage with a lower rate.
The average 30-year fixed mortgage rate has been about 3.5% in recent months, according to the Federal Reserve1. Please keep in mind that the interest rate you qualify for may vary according to your credit rating. If your current mortgage is in the 5 to 6% range, you may be able to gain significant savings by refinancing – particularly if you plan to stay in the home for many years to come. For example:
- Let’s say you have a 6% 30-year mortgage of $200,000. That would equal a monthly payment of about $1,200.
- If you could reduce that to a 3.5% rate, your monthly mortgage cost would drop to about $900 – a savings of $300 a month ($3,600 a year).
While any monthly savings would seem welcome, it is important to point out that the comparison is not exactly apples to apples. Homeowners with a 30-year mortgage who have been in the home for a few years often refinance with a new 30-year mortgage. That may help reduce your monthly mortgage payment, but it would add back those years you’ve already paid, resetting your pay-off date back to 30 years again.
However, if you continue to make the same monthly payments as before – using your interest rate savings to go toward the principle – you should be able to pay off the mortgage years sooner than you would have with the original mortgage with the higher interest rate.
You may prefer to negotiate a 20- or 25-year mortgage so that your pay-off date remains essentially the same as was with the original mortgage, while still saving money on your monthly payment with the lower interest rate.
The other mitigating factor to keep in mind is closing costs – the fees you pay the financial institution to process the loan:
- Closing costs are typically in the range of 1 to 1.5% of the loan.
- For a $200,000 home, the average closing cost was $2,128, according to a June 2016 Bankrate survey.2
- That means that if you can save $300 a month by going from 6% to 3.5% on a $200,000 mortgage, you could recoup your $2,128 in closing costs in about seven months. So even if you don’t know how many more years you’ll be in the home, refinancing would appear to be worthwhile in this case.
- At the other end of the spectrum, it may not be worthwhile to refinance for a rate reduction of 1% or less unless you are committed to being in your home for years to come. On a $200,000 mortgage, going from 4.5% to 3.5% would only save about $55 a month, so it would take about four years to make up for the closing costs.
Another option to consider would be to take out a 15-year mortgage, which typically comes with a lower interest rate than the 30-year mortgages:
- The average 15-year rate was 2.72% as of October 2016, according to the Federal Reserve3
- That was 0.78% lower than the 30-year rate.
While your monthly payment may not drop with a 15-year mortgage (in fact, it could increase), the shorter term will enable you to close out your mortgage faster while paying significantly less on interest payments.
2. Buy a home
With housing prices in many regions of the country still depressed from the Global Financial Crisis of 2007-2009, the current environment may be a good time to buy your first home or upgrade to another home that better suits your needs. Lower home prices combined with historically low mortgage rates could give you the best of both worlds in terms of finding a home to buy with affordable payments.
Keep in mind, however, that home prices have been rising in many parts of the country – and mortgage rates could also move up if the growth of the economy accelerates – so it may pay to start your home search soon.
3. Choose a fixed rate mortgage
If you are considering buying a home, you might consider choosing a fixed rate mortgage over a lower interest adjustable mortgage, particularly if you plan to live in the home for many years. According to Freddie Mac (the Federal Home Loan Mortgage Corporation), the average rate on 5-year adjustable mortgages was 2.81% as of September 2016.4 While an adjustable rate mortgage may save you some money on your mortgage payment in the short-term, if interest rates begin to move up in the future, your rate will rise along with the market and, possibly, balloon. But with a fixed rate mortgage, your rate is locked in for the entire pay-off period.
If you are already a homeowner with an adjustable rate mortgage, and you plan to stay in your home for many more years, you may consider refinancing to lock in a fixed rate. Although the fixed rate would be somewhat higher than the adjustable rate for now – and you would be required to pay closing costs – down the road, if interest rates rise, you may be happy you made the switch now.
4. Buy your second home now
If you are planning to buy a second home, this may be the time to do it while mortgage rates are low. In fact, with home prices still somewhat depressed in many regions of the country, you may be able to take advantage of the double benefit of low prices and low rates. But even if you can’t land a bargain in the housing market, you may still be able to lock in a favorable mortgage payment for a second home at today’s low interest rates.
5. Refinance your student loan
If you have a student loan from a private lender, you may be able to take out a new loan at a lower rate. A number of banks and financial organizations – including many online – offer to refinance student loans at interest rates as low as 2 - 3% for adjustable loans and 3.5 - 4.5% for fixed rate loans.5 With a lower interest rate, you may also be able to extend the terms of your loan in order to reduce your monthly payments still further. Be sure to shop around for a lender who will provide a competitive rate and appropriate terms. Be aware that some lenders will charge a fee or closing costs to refinance your loan.
6. Refinance your car loan
There are several reasons you might want to refinance your car loan. Perhaps you bought your car at a time when rates were higher or your credit score was lower – which meant you weren’t able to lock in a competitive rate. Or maybe your current monthly payment is squeezing your budget. This may be a good time to shop around for a better rate. By refinancing your auto, you may be able to lock in a lower interest rate and reduce your monthly payments.
7. Consolidate your debt
Do you have several different loans outstanding that you’re paying on each month? Many consumers have auto loans, credit card debt and even college loans that may carry interest rates higher than the current market rates. By consolidating all of your debts, you may be able to reduce your monthly payments with a lower interest rate and make your life a little easier by cutting back the number of bills you pay each month.
To consolidate your bills, you may need to go online or talk with a bank or financial institution about a personal loan or line of credit that would allow you to consolidate your bills and lower your interest. If you own a home, you may be able to get a competitive rate by taking out a home equity loan or a home equity line of credit.
8. Pay off high interest credit card balances or move those balances
Many credit card companies will let you transfer your debt from other credit cards with an extended grace period of 12 to 20 months to pay off that debt at very low or even 0% interest. Keep in mind, however, that there is usually a balance transfer fee in the range of 3 to 5%. You should also be aware that when the grace period is over, your interest rate on the unpaid balance will likely balloon back up to the normal credit card interest rate, which has been in the range of 12 to 25%.
But even if you’re not able to pay off the balance entirely, during that grace period, you should be able to make a bigger dent while paying a low or 0% interest rate. For instance, if you maintain a $5,000 balance with a 20% annual interest rate credit card, you would pay about $1,000 in interest payments over a one-year period. That means that with a 0% interest rate credit card, you could reduce your credit card debt by nearly $1,000 while making payments of the same amount (minus the transfer fee, which would be about $150 to $250 for a 3% to 5% transfer fee).
One more option: rather than using a balance transfer with another credit card company, you might consider taking out a bank loan or home equity line of credit to pay off your credit card debt. While you wouldn’t get a 0% interest rate, you may be able to negotiate a rate that is significantly lower than your current credit card rate. That would allow you to pay off your debt over time at a lower rate without the credit card balance transfer fee and the prospect of facing a ballooning interest rate when the grace period expires.
9. Invest more rather than paying off your low-interest mortgage and loans early
Consumers are sometimes advised to pay more on their monthly mortgage to reduce the number of years required to pay off the loan. But if you need to save for a new car, an education fund for your children, home improvements, your retirement fund, or any other major anticipated expenses, you might want to think twice about paying extra on your monthly mortgage.
If you already have a mortgage with a competitive rate, you may consider investing your extra money to help cover those future financial objectives. While investing involves risk, with interest rates at historically low levels, the cost of borrowing is lower now than it has been over the past few decades. Since 1985, 30-year mortgage rates have dropped from about 12.5% to 3.5% in 2016,6 which means the money you borrow at today’s rates costs 9% less than it would have 30 years ago.
What does that mean in terms of investment earnings? While past performance does not guarantee future returns, and investing may involve the risk of loss of principle, to illustrate the significance of the rate differential, let’s use the average annual return of the S&P 500 for the past 50 years since 1965, which is about 11%.7 (These examples are strictly for illustrative purposes and do not reflect actual performance.)
- With mortgage rates at 12.5% (as they were during 1985), an 11% stock market return would have given you a loss of 1.5% on money borrowed at that 12.5% rate.
- With mortgage rates at 8% (as they were during 2000), an 11% annual market gain would have given you a positive margin of 3%.
- With a 3.5% mortgage rate (as they have been in 2016), an 11% annual market gain would give you a margin of about 7.5%.
Thrivent Mutual Funds makes it easy for you to get started with an investment plan. If you don’t have the $2,000 to meet the fund minimum, that’s no problem. As long as you commit to being a disciplined investor and set up an automatic investment of $50 a month or more, we’ll waive the minimum balance. Click here to get started.
10. Invest in Your Business or Start a Business
If you have a small business or if you’ve always dreamed of starting a business, this may be an ideal time to borrow the money you need to get your business going with a low-interest loan.
As with all loans, business loan rates may vary according to your credit rating (or the credit rating of your business), as well as the value of your business, the type of collateral you could put up to secure the loan, and a variety of other factors.
In your search for a business loan, a logical place to start may be with the U.S. Small Business Administration (SBA). While an SBA loan (which is directed through an SBA-approved lending institution) is not available to everyone, if you qualify, you may be able to take advantage of the competitive rates and terms the agency provides.
Otherwise, you may be able to secure a loan for your business from a bank or other financial institution.
If you qualify for an SBA small business loan, known as an “SBA 7(a)” loan, you may be able to obtain a loan with an interest rate in the range of about 5.5% to 6.25%.
SBA 7(a) loans have a maximum loan amount of $5 million, with no minimum. The average 7(a) loan amount in 2015 was $371,628, according to the SBA.
Here are some key features of an SBA 7(a) loan:
- Interest rate. The interest rate you would be charged on an SBA 7(a) loan consists of two parts – the SBA rate and the extra margin your SBA-approved bank would charge on top of the base rate:
- The base rate is determined based on any of three widely-recognized market rates: the Fed Prime Rate, the London Interbank (LIBOR) One Month Prime plus 3% and the SBA Peg Rate. According to the SBA, as of October 2016, the SBA Peg Rate was 1.75%.8 The Fed Prime Rate was 3.5% and the Libor Rate was 0.53%9 (meaning that the total base rate including LIBOR “plus 3%” would come to 3.53%.
- Since loans obtained from the SBA are negotiated through a bank, the bank adds its own margin to the base rate charged by the SBA. For instance, for loans with maturities of shorter than seven years, the maximum spread for the bank may be up to 2.25%, and for loans of over seven years, the spread may be up to 2.75%. Those spreads may vary for loans of less than $50,000.
- Combining the two interest components would give you the total rate the borrower would be charged. For instance, on a loan of less than seven years, the rate would be a maximum of 2.25% from the bank and, if the Prime Rate is used as the base, 3.5% from the SBA for a total of 5.75%.
- Fees. Loans issued through the SBA are assessed a guarantee fee, which the lender may pass onto the borrower at closing.
- There is currently no fee for loans of under $150,000.
- Loans over $150,000 with a maturity of 12 months or less have a fee of 0.25% of the total guaranteed loan amount. (For example, that would come to $2,500 on a loan with an SBA guarantee of $1 million.)
- On loans with maturities of more than one year, the normal fee is 3% of the SBA-guaranteed portion on loans of $150,000 to $700,000, 3.5% fee on loans of more than $700,000, and an additional 0.25% fee on any guaranteed portion over $1 million.
You can find additional details on obtaining an SBA loan at the SBA website.
Even though bank savings rates have never been lower, you may still be able to benefit from today’s historically low rates by taking action to reduce your loan payments, shorten your terms, improve your lifestyle, or invest in your future with a low interest loan.
This article is not intended as a source for legal, accounting or tax advice or services. Work with your attorney and/or tax professional for additional information.
1 Source: Federal Reserve Bank of St. Louis, average mortgage 3.46%, September 2016
2 Source: Bankrate, September 2016
3 Source: Federal Reserve Bank of St. Louis, October 2016
4 Source: Federal Home Loan Mortgage Corporation
5 Source: ConsumerAdvocate.org, October 2016
6 Source: Bankrate, October 2016
7 Source: New York University
9 Source: FedPrimeRate.com, Oct. 11, 2016
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