The Joseph Group

The Price is Right for Consumer Lending

October 15, 2021

Is Debt a Four-Letter Word?

Imagine delivering a word association exercise with “debt” as the subject word. Would you expect responses like “opportunity”, “easy”, “cheap”, or “investment”? Probably not. Debt can carry a negative connotation due to our association with bad debt, such as high-interest credit cards or payday loans.

What can be lost is that other forms of debt allow for a broader opportunity set for people who do not have the means to pay for certain goods up front. Many of the businesses we patronize each day were started with a loan. Most of us have purchased homes, cars, educations, and engagement rings (in my case) with loans. I hate to think I might be homeless, carless, uneducated, and single without access to lending, but I suppose anything is possible.

The key to making debt work for you is avoiding bad debt and utilizing good, low-interest debt where applicable as an investment and/or cash-flow management tool. This is easier said than done, but the myopic view that all debt is bad and should be paid off or avoided altogether is an oversimplification of the issue.

Cash or Credit?

Many times, financing a purchase is the only option because the cash is not available to pay the full amount up-front. If cash is available for a purchase or to pay off an existing loan, the idea of paying outright is very appealing, but not always in the best interest of the buyer. Sorry, I had to get one bad pun in there.

Most basically, we should consider the cost/benefit of paying off debt or paying cash for a large asset that could be financed. For example, if Dr. Van Nostrand can pay off his loans that cost 3% interest per year with funds he could invest at 4% per year, he should keep the loans, make his normal payments, and invest his cash. This way, he comes out 1% ahead.

Of course, it’s rarely that simple since there are risks involved with investing and other considerations, but hopefully this illustrates the idea. This is a “talk to your Advisor” moment.

Refinancing Basics

If you’ve been home sick from school on any weekday since 1972, you know the gameshow referenced in the title, and arguably the most thrilling game therein; Plinko. Instead of watching that disc bounce around, exciting as that may be, imagine a contestant simply placing it on the best prize. Today’s mortgage rates are allowing the credit-worthy consumer easy access to some of the best interest rates in history, without all of the Plinko-esque uncertainty that can be associated with some financial products.

The graph below shows the movement of 30-year fixed mortgage rates over the last 50 years. If your mortgage was 18% in 1980, you paid roughly $440,000 in interest for every $100,000 borrowed over the life of the 30-year loan. Hopefully you refinanced before the term was up. Today, with a 3% mortgage, you pay roughly $52,000 in interest per $100,000 borrowed. BIG difference.

Source: MacroTrends.net

 

No one can pinpoint when rates may rise again, but we do know that there is a good opportunity right now to get “cheap” money or refinance older loans into new, lower-interest loans. While no one has an 18% mortgage anymore, it’s worth evaluating your mortgage and other loans for potential opportunities to save money.

With lending, every situation is different. There are potential closing costs, fees, and other factors to consider, but as always, consult your financial advisor if you would like to discuss whether or not the price is right on your debt.

 

  Written by Nick Boyden, Client Advisor