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Game Theory

Overall concepts needed to achieve your freedom.

Refinance Your Home – Part 4… Make Some Money!

This time around, we’re going to cover my favorite reason to refiance your home… to make some freakin’ money!

In this case, we’re not actually creating a new mortgage, we’re just pulling some money out of the equity you have built up on your mortgage over time.  Why would we want to do that?  Because your home mortgage is going to be some of the cheapest money you will ever have access to.

But wait, isn’t that risky?  What are you supposed to do with money that you’ve borrowed at a rate of 3.5-5%?

Well, beat that rate of return, for a start.   But don’t worry… I’m not suggesting putting that cash into stocks or anything.  That implies a great degree of risk.  Last thing we want is a 20-40% chance that some or all of the money you pull out of your mortgage is going to go up in smoke.

So what do we do with the cash?  If you’ve been reading this blog for any period of time, you know that we’re big fans of “Fed Watching”.  The American Federal Reserve is the world’s largest bank, and they’re charged with making sure that the American (and to a smaller extent the world) economy doesn’t accidently jump off the top of a skyscraper.  Sometimes, that means they end up bailing out asset classes like US bonds, or their current kink, mortgage backed securites.

As long as the world’s largest bank is snapping up mortgage backed securities, they are pushing up demand as well… which effectively places a backstop on the price movement of these securities.   There would need to be a hell of a housing crash before these securities start going down in value.

The best part?  The interest rate you collect can often be over 7%.   Pay 3.5% interest to your bank, collect 7% from other people’s home mortgages owned through securities backstopped by the world’s largest bank?   Sounds sexy, doesn’t it?

Home Refinancing Part 3 – Drawbacks

Last post, we covered how to refinance your home.

With a reduced interest rate, you have the ability to either pay down your mortgage at the same speed as before but with a lower payment, or (the much smarter alternative in our opinion) you can keep the same payment, and pay off your mortgage much, much faster.

So why isn’t everyone refinancing their mortgage everytime that the Fed announces they’re pushing back their interest rate hike schedule? Two reasons… one, the average Joe is not interested in the slightest. TV news refuses to cover it, because important events directly affecting your life isn’t their job. Getting eyeballs on advertisements is. Which means down with Ben Bernake, and up with Lady Gaga.

The second reason people aren’t refinancing left, right, and center is that your mortgage almost certainly came along with an early payment penalty. If it didn’t you would almost certainly have been penalized with a much higher interest rate, which you wouldn’t have accepted. When you refiance your mortgage, you are not simply changing the terms of your current mortgage, you are paying off your current mortgage and beginning a new one, which will incur your early payment penalty, which is in the thousands of dollars range.

So when is it a good time to refinance and eat the penalty? When you can reasonably expect to make back the money on the penalty via reduced payments within a few years. It takes a little bit of calculator time to figure out, (If my payment reduces by $100 per month, that’s $1200 a year, it will take 3 years to pay a $3600 early payment penalty) but it can definitely be worth the effort.

Home Refinancing – Part 2 Should I Refinance to Consolidate My Debt?

Another reason one may wish to refinance their mortgage is to consolidate debt.  If you have $10,000 of credit card debt that you’re paying, for example, 20% interest on, then that means that you’re paying $167 in interest every month, before you even touch the principal.  Ouch!   But if you roll that debt into your home mortgage that is being charged at, say, 5% interest, that $167 of monthly interest becomes $42.

Wow, that sounds great!  So what’s the drawback?  Well, the $10,000 of credit card debt in the first place.  How did that happen?  If it was for a one-time expense like a medical bill, no problem. 

But if that debt was racked up by a big screen TV or a 2 week vacation, you’ve got a leak in that wallet.  In which case, refinancing isn’t going to help.  The most common scenario in this case is that $167 payment goes down to $42, exactly as planned.  But then another vacation creeps into the mix before the debt is paid down.  A new video game system is released, and new games to go with it.  Aw!  Look at that puppy in the pet shop!  

Next thing you know, that $10,000 credit card debt has reared its ugly head again, and now you have an extra $10,000 of mortgage debt to boot!  So instead of $167 down to $42 a month, you’ve gone from $167 to $209!

The solution to this is to cut up that credit card and not apply for another one.  Anything shows up in the mail that feels like there’s another card inside gets thrown out without being opened.  But even that is only fixing the symptom and not the underlying problem.  We would highly recommend getting your financial house in order (become accustomed to spending less than you earn) before refinancing your home to consolidate debt.

 

Home Refinancing – Part 1

This post will be the beginning of a series that examines whether or not it is wise for you to refinance your mortgage. 

First things first, why on earth would you want to do such a thing?  Well, there are several good reasons, and the best of which is to reduce your interest rate.  

If your mortgage is fixed rate, and more than six or seven years old, you are probably paying a lot more in interest on each payment than you could be.  The general idea is that if you can save two percent or more on your interest rate by refinancing, it is worth the time and effort to do so.   A lot of finance outfits now recommend that a reduction of 1% is enough of a cut to refinance, but obviously we shouldn’t go around blindly trusting guys that get don’t get paid if you don’t refinance with them.

But there are real reasons why that rule of thumb is dropping. As we have covered in this blog previously, the Federal Reserve has dropped interest rates to an all-time low.  They have also gone on record as stating that they plan on keeping rates unchanged for a long time to come. (hellllo, Japan!)  That means that a large part of the short term risk inherent in using variable rate mortgages (you pay a lower rate now, but if interest rate rise, so does your mortgage rate) has been removed.  

So that means you can save a lot on your interest rate if you refinance your mortgage now with a variable rate for 5 years.  It requires a little vigilence on your part because you and only you will be responsible for keeping track of when to pull the trigger.  Never expect your bank to look after your interests in this regard, because your gain is their loss.

An Idea for Cash: Get Outta Town?

No matter how well you have most of your money working for you, you should always have some money sitting around for day-to-day expenses.  Not only that, but you really should have an emergency fund that holds at least three months (preferably six) of living expenses in case of, well, and emergency,   Job security isn’t what it used to be.  In fact, for many of us, job security isn’t.

 

But the question is, what do we do with that cash?  Should we just leave it sitting in a chequing account in a currency run by a government severely below the curve in budget and trade deficits collecting next to no or no interest?

Well, we could, and since we’re not talking about our entire nest egg, (hopefully) it’s not that big of a deal if we do.  However, I have a low-risk, low-reward idea that will add a few percentage points of return onto the money you have just sitting around.

Remember that the main factor in inflation by the creation of money.  If country A produces money faster than country B, then one unit of currency A will generally go down in value relative to currency B.  There are other factors of course, but this is the biggest.

Why don’t we want to be in USD?  Because while almost every country in the world runs a budget deficit, the US runs the largest deficit in the world on an absolute (number of dollars) basis, and is always right near the top when it comes to deficit per capita.  Which means they’re printing up money (causing inflation to shrink the value of their debt) at a faster rate than pretty much anyone else to make up for the shortfall.  Which also means that there are very few currencies that don’t increase against the dollar.

Let’s take the value of the USD vs another troubled currency, the Euro.  It’s no secret that the Euro has seen it’s share of difficulty lately.  Greece has defaulted, Ireland is on the verge of doing so, Spain and Italy are having to make drastic cuts in their standards of living.  But from 9/11 when America single-handedly financed two wars simultaneously, to 2008, when the “Euro Crisis” first came into the public eye, it was a march straight up for the Euro.  And even since then the Euro, one of the worlds most troubled currencies, is managing to keep it’s ground against the dollar.

Now what happens if we look at a currency that’s very stable?  Like the Swiss Franc? Observe.  Planes hit buildings, America goes to war again.  (and again, and again, it seems), and the CHF (franc) takes off.  In fact, the value of the franc has very nearly doubled since that fateful day.

Canada’s has done almost as well.  Australia has more than doubled.  Starting to see a pattern here?  It’s not everyone else that’s going up.  These countries all run deficits as well.  It’s America’s currency that’s going down.

In fact, the problem covers a lot more than the cash sitting in your bank account.  But that’s a start for now.

 

But if you go to the bank and open a foreign currency account, you may not be able to open an account in the currency you want, and you’ll definitely take a big hit (often more than 2%) on exchanging your money from one currency to another.

One solution you can use is to invest your money into a foreign currency ETF or open a forex trading account.  I’m not suggesting you get into active forex trading, as 90% of the people that get into that game come out losers.  But you can get an account, shift your savings over to it, and put it into a different currency far cheaper than you could at your local bank.   Using an ETF exposes you to a management fee (or MER), but you can  move your money there much more easily than opening a forex account.

Also, you can expose yourself to short-term bonds from other governments.  While the Canadian and Australian economies are on pretty much the same track (straight up, because they rely on natural resources that have to be harvested locally rather than industries whose labor can be outsourced), the US and Canadian gov’t short term bonds pay less than a percent, while Australia’s pays upwards of 4%.  Try getting that in a Citibank savings account.