Cheap Money = Big Opportunities

The Federal Reserve Board recently dropped the prime interest rate by one-quarter of a point to 1 percent. With the economy slumping, the Fed's been slashing rates for months now, and that quarter-point reduction dropped the prime rate to its lowest point in 45 years. To put it in perspective: in 1958, the last time interest rates were set this low, Dwight Eisenhower was president, golfing great Arnold Palmer was winning his first Master's tournament, and Congress was just establishing the NASA space agency.

How can you take advantage? You have a chance right now that may not come again for another half-century. This financial opportunity isn't just knocking at your door -- it's practically breaking that door down.

Reduce your debt

Lower interest rates means money is cheaper; financing is less expensive. You should be looking at the interest rate of every loan you have and questioning whether the rate is competitive in today's market. That includes first mortgages, second mortgages, home equity loans, student loans, and even credit card debt. If you have a balance on a credit card, for example, refinancing your home and rolling some of that debt into a first mortgage or a home equity loan may allow you to drop your interest rates by half or more. You'll also pick up the tax deductions available for a loan that's linked to your home.

Let's say you have a home worth $150,000, and you have a first mortgage of $50,000 left. You also have two car loans (at 7 percent interest) and some credit card loans (10 percent interest) to the tune of another $50,000. You could roll that additional $50,000 debt into a refinanced first mortgage or a home equity loan with a rate of 5 percent or lower.

If you are able to handle the cash flow commitment, look at reducing the length of time for your loan repayment as well. You can get a lower rate for a shorter term and save even more.
If you could do a 10-year mortgage, for example, you could probably get a rate somewhere in the middle-to-low 4 percent range. Compare that to your credit card rates, which can run anywhere from 10 percent to 22 percent.

A cautionary note

While consolidating existing debt into a lower-cost loan is a good idea, it may not be as wise to borrow a lot of additional money based on your home's current equity.

The cost of residential real estate is driven, in a large part, by the cash flow of the buyers -- what people can afford. That's what's been behind the huge increases in the price of homes that we've seen in the last few years. Lower interest rates mean that people can afford to spend more on a house, so every time the interest rates go down, the price of real estate goes up.

Even if you bought a house just a year ago, on paper you have had, in the past 12 months, an appreciation in its value previously unmatched in real estate history. If you bought a home five, 10, 15 or more years ago, you probably feel like you've hit a grand slam home run. The prices of vacation homes -- and thus owners' equity in them -- have gone up at an even faster rate. 

Do I believe all this appreciation is real? No.

I've talked to many mortgage brokers who have acknowledged that they're on an unusually high ride right now. The smart ones are banking some money for leaner days, when the phones aren't ringing off the hooks and people aren't looking to refinance or buy.

Unhappily -- and I say unhappily, because my gains on paper look
wonderful, too -- today's real estate prices are probably inflated beyond reality. I believe that residential real estate and vacation real estate prices are where the stock market was three to four years ago. They are like the prices of dot.com stocks before the market fell. Mortgage rates have already started climbing rapidly, and as rates rise, demand will fall. I believe that this housing market bubble will burst with the falling demand.

So before you take out that equity in your home, consider carefully what your financial situation would be if the amount of that equity would fall by 25 percent or more. What would it do to your overall financial situation if you had to sell the house tomorrow?

Other opportunities

There are also opportunities for non-homeowners to benefit from the lower interest rates. If your credit card rate is high, ask for a reduction. If the company refuses, shop around. (But don't be misled by "introductory rates," which usually last only a short time and often contain many exceptions in the fine print.)

If you have outstanding student loans, this is probably the best time ever to consolidate them. As of July 1, the rate for federal education loans (Stafford loans) had dropped to record lows of 3.42 percent for borrowers already repaying loans, and 2.82 percent for current students.

The Parent Loans for Undergraduate Students (PLUS) rate went down to 4.22 percent. Yes, it might take a while to go through all the paperwork to push that consolidation through. But if you can save $100 or more each month, isn't it worth it?

A note about borrowing

Unfortunately, interest rates won't stay this low forever, so I'd like to take just a minute to review one of the basic rules of borrowing:
Never, ever, ever borrow money for anything that doesn't appreciate in value or that you know will depreciate over time.

Now, I know that's a rule that's not always possible to follow.  But it should give you pause anytime you borrow money to pay for a depreciating consumer product like a big-screen television or even a big-ticket item like a car. When you borrow to pay for these things, you end up paying more for the item than it is worth the minute you step out of the store or the auto showroom.

Worse yet is using a credit card to pay for a product that has no value the next day -- like a meal or a vacation -- and then not paying off the credit card balance at the end of the month.  You will literally be paying for that meal or that vacation for years. There's no amount of rationalization to excuse that -- it's just a poor money decision. Pay cash. If you don't have the cash, wait to enjoy that meal or that vacation until you do.

There are some exceptions to this rule, however. Take auto financing, for example. One of the things that has kept this economy going is the fact that people are buying cars. Dealers are offering incentives that include zero percent financing.

Should you pay cash under these circumstances? Of course not. Zero percent means you're paying nothing for the loan. As long as you can make the payments on the principal, you have nothing to lose. When I recently bought a new car, the dealer asked how much I was going to put down. I told him nothing. "Why not?" he asked. "Because you're going to give me the money for nothing," I responded. "So I'm going to amortize my loan over 60 months, and keep my money invested."

Making conscious decisions about money is the key to building wealth. Take a look at your situation and figure out how today's low interest rates may help you. Even if you decide to refinance, you will at least have the satisfaction of knowing that you made an informed decision and did not just ignore the opportunity until it was too late.

Trevor 'Chip' Lewis, Jr., CFP, is Managing Director of PSA Financial Center, Inc. in Lutherville, Md. He was designated one of the Top 250 Financial Planners in Worth magazine in 2001, and the Top 150 Best Financial Advisers for Physicians in Medical Economics in 2002. Among other professional organizations, Mr. Lewis has been active in the leadership of the National Financial Planning Association and the National Association of Planned Giving. He can be reached at chip@psafinancial.com or via editor@physicianspractice.com.

This article originally appeared in the October 2003 issue of Physicians Practice.