Market Musings Blog

Interest rates have been so low for so long that nearly everyone has refinanced. But there are still some laggards – people who were waiting for home prices to rise or interest rates to fall further, or for their credit scores to improve, or for underwriting conditions to ease. Now that rates have popped up a bit, the refi question is tougher to answer.

Any time you refinance, you should consider the costs of the refi, and even on “no points, no closing cost” loans, there are costs. Fees include appraisal and title reports, a higher interest rate if you take cash out, a higher interest rate for “no points” loans, documentation costs, even FedEx costs to transport the refi package. “Serial refinancers” lose much in the way of savings when these costs are repeatedly incurred. Calculate your savings versus expenses to figure out how many months it will take to “repay” the costs via the lower mortgage payment, and remember to add in whatever you haven’t made up in costs from your last refi.

When you refi from a mortgage with, say, seventeen years remaining, to a thirty year mortgage, you will not necessarily save money even if your payment declines. That’s because the long life of the mortgage can result in more interest even if your rate is lower, because you pay it for longer. You can control the interest you pay by prepaying your mortgage. Making an extra payment of just $50 more per month on a thirty year, 4% mortgage saves you almost $15,000 in interest, and shortens the mortgage to a little over 27 years. Making an extra $100 per month payment saves you $26,800 in interest and shortens the mortgage to 25 years. So if you don’t need a lower payment for budget reasons, it might be better just to prepay your existing mortgage versus doing a refi.

If you need a lower payment, you might consider an adjustable rate mortgage. Fixed period ARMs can give you some relief from fluctuating interest rates because a portion of the amortization period has a fixed rate. Take a good look at the highest your rate can go, and how much it can increase in any one year. If thirty year mortgage rates are 4.5%, and you can get a 5 year ARM at 3.5% with a 1% cap on the increase per year, then it will take at least five years to reach the prevailing 4.5% rate. That’s a lot of years for savings to accrue to you. If the ARM rate can get to 7% though, you’d better be ready for that.

Another quirk of ARM mortgages is that the adjusted rate – once it does start adjusting – applies only to the outstanding principal balance, not to the original loan balance. So if after four years you inherit a hunk of money and use it to pay down your mortgage, even a higher rate may not result in a higher payment for you.

This information is just the tip of the iceberg when it comes to mortgage financing. Even your loan officer might not understand every nuance of every mortgage alternative available, and most won’t think about a particular mortgage product relative to your specific situation, so involve your financial advisor when you refi. A short conversation and a couple calculations could save you big bucks.

Looks like the nearly annual stock market correction is out of the way and we’re back to the bull trend. This rally remains the most reviled, disbelieved bull market ever, excepting the 1982 – 1999 epic bull market. Back then, as record after record fell, investors were muttering, “well, that’s the last of it, now it’ll drop”. But it didn’t. Yes, there were annual hiccups, and even a lousy year or two, but the overall trend was up.

Can this be as good as that run, which spanned nearly 20 years? Probably not, but we’ve thought for some time that stocks offer outstanding investment value, and we still believe that. And the more others don’t believe it, the better we feel about our position.

Ever on the quest for value, our favorite bargains are in Europe; in the US or Canadian banking sectors; REITs now that they’ve been clipped by higher interest rates; and the odd retail stock. Miners offer a deep contrarian play, which might take a while to work out. Junk bonds are nearly irresistible, but as always, beware the risk. 

The temper tantrums are in full flower. The markets are crying and screaming for the bottle from the Fed. But the Fed has left the crib and is letting the chips fall where they may. (Sorry about the mixed metaphors; at least it makes for colorful reading.) Today’s CNBC show was full of whiners moaning about how poorly the Fed communicated intent. Seriously? What were they supposed to do, send vibrations? give everyone a Ouija board? Probably the interviewees covered their shorts at the top, and it’s sour grapes now that they’ve been sideswiped.

We think the Fed is right to make an early broadcast. This tactic is completely in keeping with past strategy, which is to tell the markets what you’re going to do, do what you’re going to do, then tell the markets what you did. All economic players – banks, companies, consumers, the guy who brought one hundred thousand bottles to the grocery store recycling on Sunday – have a chance to adjust. We also trust this Fed. We think Bernanke wants to normalize, and we trust that he’s going to keep to that path. It would be better for the economy in the long run if we could have true price information in the capital markets, and right now, we don’t.

While we have a wary eye on the housing market and how it will be affected by higher mortgage rates, we think this market downturn is a pause in the bull market, and that the dip should eventually be bought. No use plunging in with every last dollar just yet, but a few more hundred points might give a great buying opportunity. All that cash building up from the sell off has to go somewhere, and we’re thinking it will recycle right back into stocks. In fact, even bonds are more attractive than they were a month ago. Anyone who is retired and looking for income – the job just got easier.

How to invest cash that’s meant for savings is the number one question clients are asking these days. With interest rates so low, keeping cash aside for near term tax payments, home down payments, tuition bills, etc seems fruitless. 

Unfortunately, the Fed likes it this way and since they control interest rates in the short term maturities, until they don’t like it, we have to put up with it. 

The back story is that the Fed, in order to support the economy, is keeping interest rates as low as possible. Yields on money market funds, CDs, short term Treasuries – all the instruments you use to save with in other words – follow suit. What the Fed wants you to do is move your money out to riskier investments, thereby supplying capital to the economy. But that’s not appropriate for short term needs, because if you take more risk, then the day you need your money for taxes or to cover the wire for your house purchase or to pay the next quarter’s installment at Harvard will be the day the market is down 10%. Your money won’t stay whole in that case, and you’ll have to find more savings. 

In investment parlance, this is called mismatching assets and liabilities. You know your bills are due shortly and you know how much they are. You must match your savings vehicle to those considerations, both with respect to time and amount. What you earn is less important than simply having the money be there. 

That said, there are a few tricks you can employ:

• Figure out when you need the funds and buy a CD or a Treasury bill due just before that time. CDs often yield more at credit unions or community banks. Try there instead of the largest banks in your market. 
• If the time frame is less certain – you plan to buy a house sometime in 1-3 years but you could also find one tomorrow – use a short term bond fund like Vanguard’s Short Term Bond Index fund, which yields 1.3% today. Keep in mind! it may lose money. It trades, whereas CDs do not. So if short term interest rates rise, you could lose principal. But it might be worth that risk if your time frame is on the longer side of short. Sometimes you can even get checking privileges on these short term funds, so when you need money, you can simply use a check.
• Use www.bankrate.com to find the highest yielding money market funds. These will likely be much higher than what your bank offers. As always, be careful if you choose the very highest rate. High rates may come with catches, like a poor quality institution, a lock-up on your funds, fees, or something else.

Happy yield hunting!