Cheaper mortgages offer planning opportunity
Although rock-bottom interest rates are playing havoc with investment returns, they offer a retirement-planning opportunity that adviser Marguerita…
Although rock-bottom interest rates are playing havoc with investment returns, they offer a retirement-planning opportunity that adviser Marguerita Cheng now uses regularly: mortgage refinancing.
“For our reviews, we ask clients to bring in their mortgage statements and investment statements,” said the Ameriprise Financial Inc. financial adviser. “Since you can't control markets but can control what you save and spend, why not lock in a lower rate today and save more money for the future?”
Just last month, Ms. Cheng met with a 55-year-old client, a federal employee, who wanted to replace her 30-year 5.25% mortgage with a 15-year 3.25% mortgage so that she and her semiretired husband, a professor, could be almost debt-free once they stop working.
The couple owes $116,000 on the remaining 20 years of their mortgage, with a monthly principal and interest payment of $1,365. The refinancing not only would shorten the term of mortgage by five years but reduce monthly payments to $1,268.
“These clients have already been making extra principal payments, so if they continue, they can be fully paid off in 10 years,” Ms. Cheng said.
Given the Federal Reserve's decision last month to keep the federal funds rate in the 0% to 0.25% range at least until the end of 2014, many advisers think that replacing higher-cost debt — principally home mortgages and credit card balances — or paying it down faster, offers a savings opportunity that is more attractive than many investment returns.
In addition, advisers, worried about future inflation, feel that it's wise to lock in today's low rates.
“If you have a fixed-rate mortgage, you're happy if inflation goes up: The size of your debt gets smaller in real dollars,” said Christopher Van Slyke, an adviser with Trovena LLC. “If you have a variable-rate loan or a credit card, you're in big trouble.”
STRIKE WHILE THE IRON IS HOT
But other advisers say it may make more sense, depending on a client's circumstances, to use this low-interest-rate period to invest in the stock market for the long term.
“If the client isn't struggling to make payments on a 15-year mortgage at a 3.5% rate and they have no desire to pay down the debt, then I wouldn't encourage them to accelerate paying it off,” said Scott Brewster, a fee-only adviser at Brewster Financial Planning LLC. “They'll benefit by investing that money.”
Other advisers note that refinancing may not make sense under certain conditions. For example, a client who owes more on their home than the house is worth might end up with mortgage debt that's not tax-deductible, said fee-only adviser John Sestina.
Since 54% of U.S. retired households own their home outright, according to Strategic Business Insights, it would seem that eliminating mortgage debt must be a priority of retirees and pre-retirees. (Nevertheless, about 11 million retiree households carry mortgage debt of at least half their home's current value, according to SBI.)
One indication of the desire to whittle down debt is an increase in the number of refinancings involving 15-year mortgages, which went from about 25% of refinancing applications in May 2011 to about 30% in October.
“While the 30-year fixed-rate has been, and remains, the most popular mortgage product, the 15-year is gaining in popularity as more and more Americans are deleveraging,” said Matthew Robinson, a spokesman for the Mortgage Bankers Association.
After they focus on lowering fixed-rate debt, many advisers turn their attention to high-cost variable-rate debt.
As of Feb. 8, the average credit card was charging about 14.91% in annual interest, according to weekly data from CreditCards.com.
In addition to encouraging his clients to use cash instead of plastic, adviser Rett Dean, principal of Riverchase Financial Planning LLC, watches rates on variable-rate lines of credit that are offered by local banks and can be linked to a brokerage account.
“Clients believe that the rates on credit lines are locked in,” he said. “But often it's a floating rate, and if you draw down from the credit line, the interest will be based on what rates are at that moment.”
Eliminating floating-rate debt is worth discussing with clients in their 50s who are still working and don't have to direct retirement cash flow to pay credit card balances.
“If you're in an above-average credit quality category, you can get a lower rate on your fixed debt — and then it becomes less consequential than the revolving debt of the Macy's charge card,” Mr. Dean said.
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