Uncommon Cents

It’s tax time and I am trying to gather my tax forms from a few different financial institutions, some of which I have accounts that are either untouched (emergency fund money gaining a small bit of interest) or on autopilot (making regular investments every month).

In the process, despite having passwords I am sure are correct, I have been locked out of two accounts and have to call to get access restored. The most hideous offender in the overly secure account category is Treasury Direct, where I have now been locked out three times; I used to be very happy with them but awhile back they started using an onscreen keyboard with somewhat randomly placed keys in combination with a bizarre plastic security card where you had to play what was like a virtual game of bingo to get your account accessed.

If there was a better alternative to them I’d use that. While I appreciate the need for making sure people’s money is safe, there’s nothing more annoying than an overly secure account–resulting in a lockup.

I have to get this fixed soon, not just so I can make sure I still have the proper buys scheduled, but to get my tax forms.

The Federal Reserve met today and it appears that interest rates will stay low for some time to come.

While this is not the best news for savers who are already struggling to find “high yield” or money market accounts paying even two percent–and regular brick and mortar banks tend to give even worse rates–if you’re looking to borrow money or refinance a mortgage, this could really help.

In combination with the extension of the Federal Housing Tax Credit, this might make more first time homeowners out there; it could also really be a big deal for folks who are trying to refinance a mortgage.

Take advantage of those great rates if you can. They certainly won’t last forever. We already did by refinancing the mortgage in 2009 to 4.25%, a rate I’m ecstatic about. It wasn’t a fun process, but it was worth it.

One of the nice side benefits of the low interest rate environment is that mortgage rates are continuing to stay low. I told the story a few months back about refinancing the mortgage here to a 4.25% fixed rate over 30 years; apparently, according to this CNNMoney.com story, mortgage rates have dropped for six weeks in a row, and some are seeing rates below 5%.

If you have either enough money for a decent (at least 20%) down payment on a purchase or are refinancing with sufficient equity, have a pretty high credit score, and a secure job with a decent income, it may still be the time to refinance.

Personally, we cut hundreds of dollars a month off of our mortgage payment every month and dropped about a point and a half (more, actually) off of our rate, so I’ve been really happy with our refinance. If you can drop a point on your rate and you have more than seven or so years left on your mortgage, it may be well worth your while to refinance yours too! Think about it.

While I do talk a lot about investing, the reality is that we all need a place to put “chicken money”–money that we really can’t afford to lose. These include emergency funds, for instance, or money that we need to pay bills at the end of the month.

One of the things that’s happened with the low interest rate environment we’re in–where mortgages are in the 5% or lower range–is that money market or high yield savings accounts are paying next to nothing in interest.

Capital One Direct, where I have an online savings account, is paying 1.60%; ING Direct’s Electric Orange checking account is paying 0.24% on amounts under $50,000; iGoBanking is paying either 1% on its checking or 1.67% on its savings; and Virtual Bank is paying 0.80% under $10,000.

These are not making me want to save–it’s making me want to spend or borrow.

Which is exactly what they’re supposed to do, but I still need to have some kind of area where I save a little.

I wish I could find some accounts that would pay a little better interest. Please?

One of my coworkers told me this during a lunch break. Knowing her, I was not surprised, although I’m not sure if there’s much of a way to help her:

“My husband is convinced housing prices will drop to the point we can afford to buy a house. But we’re not saving anything.”

This looks like a missed opportunity waiting to happen. The days of the freewheeling mortgage brokers are gone; it’s so much harder to get a loan now than it was when the housing market was booming it’s as if everyone has done a complete 180. Granted, it really needed to be harder than it was, because the way we got into this mess is by lending people who had no chance of paying it back–and who may have been a lot less than honest about their financial situation when applying for the loan–a lot of money. Turns out they couldn’t pay it back, so now the lenders are gunshy and wanting everything verified to the nth degree.

However, that said, it’s not impossible to get a loan–all that has to happen is that you need a strong credit score and a reasonable down payment.

My friend is in grave danger of missing the boat here. As evidenced by my mortgage refinance not long ago, rates are very low historically (even if it’s become impossible to get the 4.25% we did), and home prices are still coming down. But without saving for a down payment, there’s no way my friend is going to be able to get a new house when she and her husband think prices have come down enough.

Despite all of the changes over the years, the reality is still this: the basics for buying a house are good credit and a down payment. Without these–especially now–there’s no way to do what she and her husband want to, and without saving, they definitely won’t be able to get the house they’re hoping for anytime soon.

The overall effects of interest rates on the economy can be summed up pretty quickly–low interest rates encourage borrowing and help those who owe money; that encourages spending and therefore economic growth. On the other hand, high interest rates benefit those who like to save, as they’ll get better return on their money, and discourages spending, therefore discouraging economic growth. That said, on a micro level, who actually benefits from low interest rates?

The people who benefit most from low interest rates are those who owe money or are looking to borrow money. For instance, with the incredibly low interest rates on 30 year fixed mortgages available earlier this year, I refinances the mortgage on the house from the very decent 5.85% obtained a few years back to 4.25%, shaving hundreds of dollars off of the monthly payment. Also, if I wanted to borrow money to say, start a business, I could likely get a much better rate than I would have a couple of years back.

On the other hand, the very low interest rate climate hurts savers. My online savings accounts that were paying rates in excess of four percent are just over one percent now–and I’m afraid to check what the regular passbook savings account that my mother uses at the local brick and mortar bank is paying (not long ago it was paying a quarter of a percent when the online accounts were still above three percent). Folks who are looking for certificates of deposit as safe places to park money are having difficulty finding interest rates at three percent for almost any term (Bankrate says it’s possible to get 3.06% on a five year CD).

Remember that in recent years inflation has been about three percent per year, which makes it pretty clear that locking in a paying rate for a long period of time is a real risk if inflation shows up again with a vengeance; on the other hand, it’s a great time to refinance debt or buy a house if you can come up with a nice down and really can afford it over the long run. In any case, we all benefit from low interest rates if we owe money (or are looking to borrow), but all hurt by them if we’re saving somewhere.

I’m currently working through a monstrous audiobook (sixteen compact discs worth of content!), The Age of Turbulence by Alan Greenspan. Greenspan, as we know, is the former Chair of the Federal Reserve, one of if not the most powerful position in the world.

I’m about a quarter way through it. It’s an autobiographical work, but while it discusses his personal life and origins, it also chronicles some of the most important events of his lifetime, such as the crumbling of the Berlin Wall, 9/11, and the breakup of the Soviet Union and what his views on each were. It also discusses, of course, economics and his decision making processes on the policy of the Federal Reserve, his relationship with presidents back to Richard Nixon, and his admission of using “Fedspeak”–vague and hyperbolic language when addressing issues as Fed chairman.

I thought this would be a boring book, but so far I’m proved wrong. I will give a complete review when I’m done.

What’s interesting about the recent economic downturn is that while the news is not great, there are some ways that it’s possible to make positive financial lemonade out of the lemons coming out of the financial situation.

Use lower rates to refinance your debt: We refinanced the mortgage at 4.25% for a fixed 30 year; we were doing fine with a 5.85% fixed 30, but this is even better. If you have debt, see what you can do to refinance it. You may also consider consolidating debt since there are tax advantages to a mortgage that there aren’t to other types of debt, but be careful: if you got into consumer debt by overspending, you must get your spending in line in order for this to work out for you long term or you’ll end up in exactly the same place.

Buy at sales, price reductions, closeouts, and liquidations: When the economy is this bad, laws of supply and demand come into effect–reduced demand results in increased supply, and sellers must reduce their prices in order to sell just about anything. If sellers actually go out of business, while unfortunate, often gives lots of opportunity for buying goods at discounted prices. If sellers are willing to let things go for a song and you’ve got the cash saved up to buy, you’re in the driver’s seat.

Keep investing: Don’t stop your investment plan. The best time to buy into a market (if you’re into market timing, which I’m not) is when the market is down. If you have the kind of investment plan I do, you’re buying in regularly anyway–just don’t stop. I know of one coworker who stopped investing when the market went south by 20%–and hasn’t gotten back in. She’s missing out on the current 30 plus percent gains that have been happening the last few months with any new money–money that could have gone into the market when the market was in full retreat.

There’s some pluses–not many of them, of course, but there are some–to an economic downturn. Take advantage of low interest rates, slow sales, and the retreat in the stock market by using your money wisely. If you’re prepared, you can do well even when the economy is putting out more lemons than the domestic automakers.

If you have a low, fixed rate mortgage, prepay doesn’t typically make financial sense. However, there is one thing that a mortgage prepay does get you: peace of mind.

It’s the same kind of peace of mind you get from being free of the car loan, the student loan, or the credit card debt, but amplified. If you’re able to pay off your mortgage early, you may feel free to quit your job or cut back on your hours. From a financial point of view, it’s like getting an investment return at the rate of interest of your mortgage, so if your interest rate is high, it could really be appealing.

It doesn’t always make financial sense, but it may make psychological sense. If it does, really think about it! Nothing wrong with it, especially if it puts you at ease.

On Twitter (gee, I seem to be saying that a lot), one of my buddies and I had a quick exchange on the pros and cons of prepaying a mortgage, which I thought I’d expound on here.

This discussion assumes that you don’t have an exotic, difficult to deal with mortgage like an adjustable rate mortgage. If you do, you’d likely be much better off finding a fixed rate mortgage than worrying about paying beforehand. It also assumes you don’t have a mortgage with a prepayment penalty–yes, there are mortgages that will sock you with fees if it’s paid off early!

The question that was at the heart of the discussion is whether paying off a mortgage early made financial sense. The answer, as almost always, is, “it depends.”

In particular, it depends on the interest rate of your mortgage and the rate of inflation. Let’s take a quick look here.

Pretend you live somewhere (like Hawai’i) where the interest paid on the mortgage for your primary residence is deductible on both your federal and state taxes. Also pretend that inflation is in the “normal” 2-3% range. And let’s also pretend your mortgage rate is 5% (which is a pretty decent rate).

Start with your mortgage rate–right off the bat, you can deduct the inflation rate–you are paying off the mortgage with future, cheaper dollars. So 5 (your mortgage rate) minus 2.5 (right in the middle of the 2-3% “normal” inflation rate) equals 2.5.

Then consider you are deducting the interest you’re paying from your federal and state taxes, which might (depending on how much interest we’re talking about) give you the equivalent of about another 1-1.5% discount on that rate. That leaves us somewhere about 1.25% interest on that loan–we’re talking pretty cheap money. Financially, this would suggest that prepaying is not so hot of an idea–your money would better be spent in even a pretty low rate certificate of deposit if you wanted a “sure thing” or, given historical returns, the bond or stock market.

However, remember that the inflation rate is a key part of this! Right now, inflation is essentially zero, if not negative. So it’s hard at this particular time to give yourself that 2.5% part of the equation, although over time it’s likely to be true. If you can’t count on the inflation part of this scenario, the effective interest rate becomes considerably higher–an argument to prepay.

Alternatively, looking at a different part of the scenario: if you prepay the mortgage at 5%, it’s like investing your money at a guaranteed 5% rate, which is pretty darned decent these days–although about half the traditional return of stocks. If, however, you are a conservative investor, you could consider this similar to being like investing in a fixed income security such as bonds or CDs–in that case, it may be worthwhile to prepay the mortgage with the money you may otherwise use for fixed income investing. But be careful with that, because while you eliminate debt faster, you aren’t building any wealth.

And of course, the 5% mortgage rate is key to this; if your rate is, say, 7%, you just added two more points onto the equation, which would make the argument to prepay much stronger.

So, a few things to consider when thinking about prepaying your mortgage. This is, while much more comprehensive than what could be done on Twitter, just the beginning of a long discussion on some mortgage issues.