Interest Rates: How to Take Advantage of the Current Low Interest Rate Environment
Have you ever heard the phrase ‘debt averse’?
It’s a phrase that many have become accustomed to. Often, these individuals have followed a pattern of debt avoidance, coincidentally helping them accumulate wealth over their lifetime. The thought of accumulating debt or taking out loans creates an uncomfortable feeling.
However, completely avoiding debt is not always the correct course of action.
As wealth advisors, we often receive questions about debt from our clients: ‘Should I withdraw proceeds from my portfolio, or take out a mortgage to finance the purchase of a new property?
The answer to this question might not be as straightforward as you think. Let’s explore why.
Current Interest Rate Environment
The first approach to determining whether to finance large purchases like mortgaging a new property is understanding the interest rate environment.
Right now, we are experiencing historically low-interest rates. Low-interest rates create an opportunity to borrow money at attractive rates. Mortgage rates, for instance, are near all-time lows. They are currently hovering around 3 percent for 30-year loans, and 2.6 percent for 15-year mortgages. In 2018, the average rate for a 30-year mortgage was 4.54 percent. Though this may seem like a minimal difference, 1.54 percent in compounded interest over 30 years equates to a very large number. Therefore, during a low interest rate environment, it is important to understand the cost-benefit for keeping portfolio dollars invested and financing debt versus withdrawing portfolio dollars to avoid debt.
If the rate of return on your investments is greater than the interest rate used to borrow the funds, then you are better off keeping the dollars invested and utilizing a financing strategy to fund the purchase.
Refinancing debt is a strategy that all individuals should consider during a low-interest rate environment. Regardless of the type of debt you may have (mortgage, credit card, student loans, etc.), refinancing will provide flexibility in determining how to best allocate your cash flow. Refinancing reduces the interest rate on current debt and can enable a borrower to pay down their principal at a much faster rate.
As mentioned earlier, current mortgage rates are the lowest they have ever been in a generation. If you still have a mortgage with an interest rate above 4 percent, consider refinancing. When considering refinancing, make sure you understand all the costs and fees associated with the refinance. Also, it’s important to evaluate how long you plan to stay in your home. If you have a goal of moving in the short term, the cost to refinance may outweigh the benefit you receive before moving.
Strategies to Consider for Large Purchases
Personal Asset Line
Sometimes you may need to access cash for an unexpected expense – car was totaled, HVAC system needs a full replacement, etc. One way to prepare for those unexpected expenses in a low-interest environment is by utilizing a personal asset line (margin). A personal asset line allows you to borrow cash from your portfolio without liquidating positions. It’s a great strategy for funding large purchases particularly for individuals in a high tax bracket and with large capital gains in their portfolio. It also provides flexibility and a viable short-term alternative to accessing cash. There may be instances when you need to withdraw a substantial amount of cash from your portfolio in a short period of time. To better manage your tax liability, using a personal asset line or margin could be a solution.
Home Equity Line of Credit (HELOC)
Another strategy you could consider to finance large purchases in a low-interest rate environment could be opening a home equity line of credit (HELOC). This line of credit is placed against the value of your home, and available to draw upon for large purchases or unexpected financial expenses. A HELOC can be used to purchase a new vehicle or a major home improvement. It can also provide the necessary flexibility to better manage your tax liability. Similar to a personal asset line, using a HELOC for large purchases can help avoid potential capital gains or ordinary income taxes. It also allows portfolio assets to remain invested and grow over time. Assuming you can achieve a higher rate of return on your invested assets compared to your HELOC rate, than the investor is better off using their HELOC to pay for their unexpected expenses. This strategy could also be used to transition to your retirement home, providing short-term cash to buy the retirement home prior to selling your existing home.
Consider securing a HELOC before retirement. Banks evaluate your personal income levels when approving lines of credit. Applying for a HELOC before retirement is a nice way to achieve a larger line of credit than it otherwise would if your taxable income is lower after retirement. Adding a HELOC provides flexibility and is a nice addition to add to your retirement resources.
Understanding tax ramifications is important in determining the best approach for funding large purchases. Financing new property helps avoid potential capital gains tax or ordinary income taxes if pulled from a qualified account. Depending on your individual tax status, you may be required to raise more cash from your portfolio to cover the tax liability than the actual cost to borrow the funds. Instead, pursuing a strategy such as a HELOC or personal asset line will help avoid unfavorable tax consequences, while doing so at a very minimal cost during a low-interest rate environment.
The current interest rate environment has created opportunities to refinance and acquire loans at historically low rates, and it may have you questioning what might be a good option for you financially. Whether you are just starting out in focusing on investing and saving for your future, or you are a seasoned investor working on accumulating and preserving wealth, interest rates affect us all. It is important to consult with a financial professional to determine what strategy may be best for you. We’re always available to start a conversation – get in touch with us at 855-555-5455, or via firstname.lastname@example.org.
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