This is part 2 of the series, the first part is: Not Time to Refinance Your Home
Future Interest Rates With Adjustable Rate Mortgages or ARM
Right about now, when you are starting to feel better, someone will throw in your face the fact that even if your rate is good, IT COULD GO UP AT ANYTIME. That, is the second thing that is different.
Mortgage companies and customers found that changing the interest rate every month was a hassle for everyone and only created more opportunity for errors and losses both for lenders and borrowers. Almost every ARM adjusts on set periods. The most common is a mortgage loan that adjusts once per year.
In other words, if our ARM started adjusting today, we would lock in a low rock-bottom 3.25% interest rate for a full year.
What if interest rates do rise?
They will, you can count on that. When, and how fast, is another question. However, consider that everyone still considers the economic recovery that we seem to be having (or may not be having, no one is really sure) is very fragile. The last thing the Fed wants to do is raise interest rates too far, too fast, and kill off the economy again. You can expect them to be erring on the side of NOT raising rates for once.
When they do start raising rates it will be done slowly. The first rate increase will almost certainly be 0.25%. When that happens, mortgage rates will rise too. If you like, you can go refinance that day. It should be much easier to get a mortgage since that interest rate increase will come because the economy, and the banks, are doing better, so there will be less fear in lending. Assuming the 30-year fixed rate jumps a full 0.75% on the news, compare that to what your current non-adjusted rate is.
On the 5-year note, we have, it is 5.125%, that is roughly what interest rates might be AFTER the Fed starts raising them. So, there is really no downside even if rates do go up, and no one is expecting them to go up much soon.
Of course, you might not want to refinance even if the Fed does start raising rates. Why?
Because most adjustable mortgages include clauses defining the maximum amount the interest rate can go up during any one adjustment period (in our case, one-year). In our case, the rate can never change by more than 2% from the previous year. That means that if we did get locked in at 3.25%, the highest our interest rate could possibly rise to next year would be 5.25%. Again, compare that to what you could refinance to today with no fees and no closing costs.
In other words, we would be set from now until June 2011 without the possibility of our interest rate increasing any amount that would justify refinancing. In fact, through June 2012, we are guaranteed to not pay anything higher than 7.25%. That isn’t rock-bottom, but hardly sky-high either.
Refinancing will cost you a couple thousand dollars in fees most likely which means it could take years to break even once the rate you have locked in for 30 years is actually lower than would you could have by not refinancing. Again, by way of example, if we could get something like a 5.0% 30-year fixed mortgage for just $2,000 worth of TOTAL costs including any administrative fees or charges, it would be June 2012 before we started saving any real money on our monthly payments. It could be 2014 before we started coming out ahead.
So, while not refinancing guarantees us a low-cost mortgage through June 2011, and an average mortgage through June 2012, actually refinancing can’t even POTENTIALLY offer us any advantage until at least 2014!
Can you guarantee that your job, desired home location, family size, and lifestyle will stay the same through 2014? Me, neither. We won’t be refinancing.
(Just for full disclosure, the Note I’m referencing actually adjusts at the end of 2009 making this a slightly bigger gamble, but still a pretty safe bet. No one expects rates to rise much between now an the end of 2009.)
Time To NOT Refinance Your Mortgage
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The world of adjustable-rate mortgages isn’t very old when it comes to the general population. Sure, the product has been around for a long time, but it wasn’t until late in the 1990s that it turned into the kind of thing your average neighbor would have. That lack of age also means a lack of experience.
So when media outlets start reporting about “Black Wednesday” when mortgage interest rates shot up, and then follow up it up with “news” asking if homeowners who didn’t refinance already have missed the boat and wondering if there will ever be lower interest rates again, the average person starts to worry.
Many homeowners are doing the wrong thing right now, or are up nights worrying about something they don’t need to worry about just yet, because now might just be the perfect time to NOT refinance your mortgage.
With the economic recession and collapse of the banking industry, as well as the drying up of the credit markets, the Federal Reserve Board (FED) has cut it target short-term interest rates to near zero—officially 0% to 0.25%. Doom and gloom headlines about socializing banks, Chrysler and then GM bankruptcies and of course, plenty of stories about how bad the lending business is may have put the silver lining about your adjustable rate mortgage in your blind spot.
If you have an adjustable rate mortgage that will start adjusting it’s interest rate in the near future, you may have been waiting with dread for that date to arrive. This likely applies to you if you picked up a 5-year ARM toward the end of the real estate bubble, or a 7-year ARM or 10-year ARM earlier on.
The conventional wisdom has always been to refinance out of your ARM before the interest rate begins adjusting. The idea is that you don’t want your mortgage interest rate behaving like a credit card interest rate and changing your mortgage payment every month. But, two things have changed so much that the conventional wisdom might actually steer you down the wrong path.
ARMs Adjusting Interest Rate Lowest Ever
While the Fed has struggled to keep long-term interest rates on new mortgages as low as it would like, it does not have that problem in one area. Most existing ARMs are tied to interest rate index. Usually, the adjustable rate mortgage interest rate is equal to that index plus a specified amount. The index your interest rate is tied to and the interest rate spread added to that rate are spelled out in your mortgage documents, or more specifically, in your “Note.”
For example, a 5-year adjustable rate mortgage we have on a property is set based on the weekly yield on the United States Treasury securities adjusted to a constant maturity of one year. That sounds like a nightmare, and it probably is if you actually have to calculate it buy you don’t since the Federal Reserve Board publishes that number daily.
The United States Treasury Securities Adjusted to Constant Maturity of One Year index is 0.50%. Actually, it fluctuates daily and for the end of May was 0.49%. It’s been lower the first few days of June, not higher.
In other words, on this particular mortgage, if our interest rate were to adjust today, our new adjustable interest rate would be 3.25%. I dare you to find a mortgage you can refinance into with that interest rates with no closing costs or loan fees of any kind, because when it comes to a mortgage you already have, you pay zero fees, with no fine print!
What if mortgage rates go up after you decide not to refinance
529 Plans New Rules for 2009 and 2010
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If you have money in a 529 plan to save for college, good for you. 529 plans represent one of the best vehicles for educational savings, and with the cost of tuition skyrocketing faster than anyone can keep up with, they also represent the middle class’ only hope of paying for even 1/2 of a college education in the future.
When 529 plans were created, lawmakers attempted to correct some of the perceived issues with 401(k) plans which are similar in nature, but with a different goal. One of those issues was that the majority of 401(k) plan participants were doing it wrong, that is, investing incorrectly. One such problem was changing their investments too often in response to news events or media hype.
The solution implemented in 529 plans was that they were restricted to just one reallocation per year. In other words, if you started 2009 with half your money in the S&P 500 fund and half your money in the International fund, you could change that to something else, but only once for all of 2009.
This restriction only applies to monies already in the account and exchanging that money between investments. You can change where NEW money goes at any time. Thus, in the example above, the account owner could switch to 25% S&P 500, 25% International, and 50% bonds on March 1st, but then they could not adjust that mix again until 2010. However, the investor could elect to have all future contributions to go 100% to the Money Market fund on March 20th, and could change that again on April 19th, and so on, at any time.
2 Re-Allocations Investment Exchanges in 2009
Congress passed a law changing the rules for 2009 only. In 2009, the account owner of a 529 plan may make TWO changes to the investment allocation of the existing funds. One could therefore make a change now, and another change in September, for example. The extra change cannot be rolled over and it does not apply to 2010, as of this writing.
Ironically, this action only proves the point. Congress knows that people will be freaked out about their investments this year. That means they will want to make the same kind of current events based investment decisions that were trying to be avoided by having the once a year rule in the first place. Doubly ironic, is the fact that if one were going to “go safe” it probably should have been done in 2008.
With the new twice this year feature, Congress allows people to go safe now (too late) and then go back to “normal” later this year (probably too late as well).
If you are sitting across the dinner table from a 15 year old, then you have a pretty tough call to make, especially if you have already rung up huge losses. You are still probably better off sitting on the investment strategy you calmly and carefully analyzed when you were not scared, assuming that is how you picked your investments in the first place. While there would only be 3 years until the account was started to be withdrawn, if you are looking to use the money over a full 4 or 5 years, then you are still looking at 7 or 8 years total. There will most likely be some kind of recovery during that period.
Bond prices can only go down from here because higher interest rates cause lower bond prices and interest rates are already at zero…
If you are looking at someone under 10, do NOT panic. Now is not the time to go 100% bonds, and it is most certainly NOT the time to go 100% money market. The 20% recovery the market has already had from its lows earlier this year was the best way to get some of your money back. You have 8+ years until the money is needed, let the markets do their work during that time.
You current contributions should be going into equities. Pick a market index fund, or one of the “growth” allocations available in your plan. Yes, there may be some more downside in this market, but you will be buying cheap if you are buying into stocks now.
The opposite is true of bonds. Never forget that bond prices go DOWN when interest rates go UP. Interest rates are currently set at 0% basically. That means it is GARAUNTEED that interest rates cannot go down, they can only go up. Do the math and that means that for anything but the short-term bond prices can only go down. Why would you buy an asset that is assured of losing value?
Once any sort of recovery begins, the Fed will have to start raising interest rates, and when they do, bond prices will fall. The only way to avoid this is to own individual bonds and hold them until they mature. For bond mutual funds, they can only lose money once the recovery begins.
A quick word about money market investment options: College costs are increasing at 7% per year on average. If you are earning 3% in a money market (fat chance) you are losing 4% of buying power each year. Yes, it is painful to watch the account value go down, but it will come back and over time, the market returns 9% to 11% depending on who you ask, and how you count. In other words, your only hope to keep up with the 7% inflation of college tuition is to get that 9% in the stock market. There is no other choice.
If you can’t or won’t listen, then that is too bad for your children, but AT LEAST make sure your current contributions are going into equities. They won’t go down much more, but they could go up a lot. Maybe that will be enough to make up for making the other decision.
Too harsh? Leave a comment or shoot me an email.
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Sell Banks Stocks or Buy Bank Stocks
By · CommentsOk, here it comes.
After the government released the results of its stress tests, banks are scrambling to come up with ways to raise huge amounts. It seems that the government money that was a much vaunted and absolutely necessary lifeline to banks has become tainted now that it comes with, horror of horror, strings on how the money can be spent. As if the banks ever handed out a huge loan to anyone without some sort of control on the collateral.
Be that as it may, banks want out of TARP and they want out now. Even banks that would be much better off holding on to their TARP dollars are looking to buy back the government shares of preferred stock that they had to put up in order to their money. Seems there is a feeling that the banks that do keep their TARP funds will be viewed as sickly or less stable than their counterparts who repay, regardless of the cost or wisdom of doing so.
The only way for these banks to raise the kinds of dollars being thrown around is by selling off assets, which is fine if they are not part of the core business (which begs the question why they were acquired in the first place), and by selling more stock to the public. The latter means undoing decades of stock buybacks in some cases, and flat-out printing new shares in other cases. Either way, that is a huge flood of bank stocks headed for the market.
Buy, Sell, or Short Bank Stocks?
What’s an investor to do?
Get out of the way.
Frankly, there are too many variables here for any bank stock investment to be anything other than an educated guess at this point. Trading on banking stocks based on whatever methodology or information you have analyzed can be nothing more than the equivalent of counting cards in blackjack and may be nothing better than picking red or black on a roulette wheel.
When you start using gambling analogies to discuss trading options, its time to step back.
At issue, is what will happen as the various banks strive to implement their business plans to both get out from under the government thumb and pay back their TARP money. What is about to occur is unprecedented.
Typically, large corporations carefully time any additional stock sales or new issues into markets viewed as particularly favorable to their goals. Nobody is saying that is the market we are looking at today, and yet, oodles of banks are looking to unleash the single largest infusion of bank stocks into the market in…well, forever.
Secondly, as banks focus on implementing their TARP pay backs and mending their image, they are more likely than ever to take their eye off the ball when it comes to actually running their businesses. Already, companies have made consumer relations missteps that have become front page news, and Congress is talking about making credit card issuers make money fairly, instead of with fine print and contract double-talk, something most of them haven’t done in years, and may not be able to do anymore at all.
In other words, it is completely possible that thanks to a recovering economy, the largest government intervention in recent history will be a huge success and the Feds will get back all of their investment dollars and get to claim credit for saving the economy. Along the way, bank stocks may absorb the huge infusion of supply and continue upward.
It is also completely possible that more than one bank will bungle throwing off the government shackles, or in doing so weaken itself too much to stay competitive, resulting in the credit crunch failing to unwind, a short-lived dead cat bounce in the economy and the onset of a second recession or banking crisis, this time that may cause the banks to stay in government hands for good, or that will leave investors holding the bag…and their shiny brand-new shares of common stock that are now worthless.
Go buy Wal-mart or GE, or company that’s upside during a recovery is not tied solely to how it plays the game during the next 10 months.
