• WisBusiness

Wednesday, May 20, 2009

Options to consider after refinancing


By Kevin McKinley
Last month's column encouraged homeowners with good credit and a good chunk of equity built up in their homes to at least consider taking out a new, 30-year fixed-rate mortgage at today's record-low rates. The result might be a large sum of money, a smaller monthly payment, or both.

The reasoning behind this proposition is that the same economic measures that have produced these low rates may also bring about higher inflation, and subsequently higher interest rates.

If that occurs, those who borrow now will not only be repaying their mortgages with dollars that are declining in value (a good thing for the borrower), but can also use the proceeds from the new loan to ensure that they never have to borrow money at higher rates in the future.

But the key factor in making this work is what you choose to do with the proceeds of the new loan, or the extra money you get from lowering your monthly payment. Here are the best places to salt away any extra savings.

Pay off other debt

If you've accumulated some debt via credit cards, car loans, or student loans, you're probably paying a higher interest rate on those debts than you would be paying on a new 30-year mortgage.

Unlike the credit cards, the interest rate on a fixed-rate mortgage can't be raised at the whim of the lender. And unlike just about all other debt, the interest on your mortgage might be tax-deductible, rendering the net cost of the mortgage even lower than the stated rate.

Even if your only debt is an outstanding balance on a home equity loan or home equity line of credit, you're probably going to be able to cut your interest rate by rolling the old loans into a new fixed-rate mortgage.

Best of all, whether you get a lump sum of cash or a lower monthly payment from the new mortgage, you can stash the savings and use it to pay cash for future purchases for which you otherwise would have had to borrow money at a higher, non-deductible interest rate.

Stay at the bank

If you're a little apprehensive about pulling equity out of your home when you don't necessarily have to, then perhaps you shouldn't venture too far from the financial institution that gives you the loan in the first place.

Depositing the money in a certificate of deposit or two will keep the money relatively-readily accessible if you need it in an emergency, or decide to pay the mortgage off sooner than scheduled.

The only drawback is that the rate you earn on the CDs may be a couple of percentage points below what you're paying on the mortgage—a relatively small price to pay for the increased liquidity you've achieved.

And that rate disadvantage may not last forever. If that higher inflation and interest rate scenario comes to fruition, you may be able to renew those CDs at higher interest rates than what you are paying on the mortgage (and if this happens, try not to gloat in front of your banker).

A retirement boost

Of course, there's an even better place to get an immediate, higher rate of return on the money, especially if you winced a little when you opened your most recent retirement plan statement.

Raising your at-work retirement plan contribution to the maximum amount allowed (in 2009, it's the lesser of your earnings or $16,500, $22,000 if you're over 50) may benefit you in two ways.

First, you get an automatic reduction in this year's tax bill, usually from $200 to $400 for every extra $1,000 you are able to set aside. Then, your earnings are sheltered from taxation until you retire.

Finally, equity prices might shock everyone and actually rise at some point during the next several decades, which may help you earn a rate of return equal to or higher than what you are paying on your new mortgage.

But it might be prudent to keep your retirement plan investment allocation at a moderate mix of stocks, bonds, and cash, just in case it takes awhile for a new bull market to begin.

Next month, some slightly less conventional destinations for your mortgage proceeds.

-- McKinley bought his first share of stock at the age of 14, and began working for an investment firm at 17. After graduating from the University of Wisconsin with a degree in economics and history in 1988, he became one of the youngest licensed financial advisors in the country. He is now a Certified Financial Planner practitioner, and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin that provides fee-based financial planning and investment management to individuals and families. Read McKinley's complete bio

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