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0% Interest Rates: Buy Or Refinance?

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Forge Your Wealth is meant for education and entertainment and should not be used for financial advice.

With the fears of investing due to the Coronavirus outbreak the US Federal Reserve has implemented 0% interest rates. The idea is to entice people to borrow money to make large purchases or to invest. But even with 0% interest rates is it a wise idea to take advantage of these? In this post I will only bring up what you should try in the case of the eliminated interest rates. I will bring up how interest rates work in a future post.

Should You Take Out A New Loan?

With the eliminated interest rates this would be a great time to take out a loan, but only in some instances. You should only take advantage of the 0% interest rates under these criteria.

  1. You intended to make the purchase before the elimination of interest rate.
  2. The price of the purchase is not too much.
  3. The interest rate is fixed or the loan term is for less than 3 years.
  4. You have no other debts to worry about.

You intended to make the purchase before the elimination of interest rate

One of the purposes of 0% interest rates is to convince you to take on debt when you would otherwise not. Do not fall for that. One of the worst things you could do it to take on debt when you are not prepared.

If you have been saving up for a purchase or for an investment in your business, go for it. Interest will be lower than it normally is. But keep in mind that interest rates alone will not affect how financially sound the debt is. Before anyone asks in the comment section whether they should borrow money to invest in the stock market or anything passive I will say this. It’s a bad idea to borrow money to invest in the stock market before and it still is with 0% interest rates.

The price of the purchase is not too much

Do you know what the interest rate alone does to the price of your purchase? Nothing. The reason a lower interest rate commonly makes you think to make certain purchases is because it lowers your monthly payment. It will have no effect on the principal you have on your loan.

Lower interest rates will not affect the cost too much. In fact having an interest rate 1% lower for a 30 year mortgage will only affect the monthly payment by a little more than $100. That’s not nothing, but I would not make such a crucial financial decision based solely off of saving a little more than $100 each month up front.

Furthermore just because there are lower interest rates does not mean the loan rates will be smaller. With the elimination of interest rates many institutes have raised mortgage rates due to the higher demand. With that change due to higher demand I would imagine the upfront price of many purchases have become larger with more people trying to take advantage of these lower interest rates.

The interest rate is fixed or the loan term is for less than 3 years

It is easy to think that lower rates on your loan are good and many are excited to try to take advantage of them. They become so excited that they take out adjustable rate loans to get the lower interest. If you try to get a lower rate via an adjustable rate loan you may take advantage of the lower rate for a short while. But they are called adjustable for a reason. They can (and probably will) rise in a matter of years.

If you are going to take out a loan now you should either go for a fixed rate or only take out the loan for a short term. Taking out a fixed rate loan is straight forward. The rate should remain fixed throughout the term of the loan. Otherwise you should take out as short of a loan as possible, preferably three years. This way the rate should not change much within the short term of the loan.

You have no other debts to worry about

As mentioned the 0% interest rates are meant to entice you to take out new debt to stimulate the economy. Let’s be honest the US Federal Reserve cares far more about the US financial situation than your own. In general, the worst financial decision you could make is to take on additional debt especially without a plan.

If you already have some debt you should not take on an additional debt. However you could still take advantage of the 0% interest rate with your existing debt.

Refinancing Old Loans

If you already have a loan you could try to refinance your loan. Refinancing your loan is best summed up as applying to a different lender to loan you money (preferably at lower rates) to pay off your current loan. This is a common way to lower the costs of your loan.

Refinancing a loan only works under certain criteria though. For instance, refinancing frequently leads to new closing costs which can cost 2-5% of the principal. In addition there could be penalty fees for early payments in your new loan. If you work in finance you know about these fees because they probably provide your company its profits. To everyone who thinks these fees are ridiculous, would you complete massive paper work, negotiations, and take on risk for free? Refinancing money is not free.

Times Refinancing Makes Sense

There will almost always be fees for refinancing, but it does make sense to spend some money to save even more. It must be done in a particular way though. When you refinance your loan you should aim to have the term last at most half as long as the original term and the new term should be shorter than the remainder of your current term. If you are refinancing a 30 year mortgage you should take out a 15 year mortgage, but this may only cost less if the new term is shorter than the remainder of the original term. If you only have 10 years left of the 30 year term refinancing a 15 year term will probably cost you more.

Even these criteria may not be cost conscious though. Usually refinancing a loan means you cannot make early or larger payments than what have been written out. If you have enough to pay for the fees upfront it may be better to instead use that money to make an earlier payment of that amount. In the case of a mortgage just paying $50 extra a month could save you $12,000 and just an extra $250 extra a month can save you close to $50,000 over a 30 year mortgage on interest alone. Paying a few extra thousand upfront could have a similar effect.

The details of your loan will determine which path would save you more money. You should discuss the matter with an expert to determine whether refinancing will save you money. Note I am not an expert on the matter nor have you signed a mortgage with me so I cannot determine the best path for you.

What If You Have No Debt Nor Plans To Take On Debt Soon?

I cannot believe I am saying this without any sarcasm, but it is perfectly okay to have no debt and not plan to take on any debt. The 0% interest rates may be a good opportunity to save you money on your next purchase it is just an opportunity. More opportunities will come up. The US had 0% interest rates after the economic crisis of 2008. If you have a fear of missing out don’t worry you probably won’t. When the US first started this after 2008 they did not raise the rates until December 2015. That was for over 7 years and they just restarted. So the only reason you should fear missing out is if you believe that the US economy is recovering, and I mean truly recovering.

Do real estate investors have plenty of inventory so they do not have to worry about the government providing low interest rates just so people can buy their houses? Is it common to find jobs that provide good health insurance that can pay for the rising healthcare costs and to have salaries that are rising above inflation rates? Can people pay less than a small fortune to raise a child except under the most frugal conditions? If the answer is yes to all of these answers then yes the economy is truly recovering and your worries about missing out may be legit.

Final Thoughts

0% interest rates are great opportunities to make purchases for a home or to invest in a business. They are just opportunities though and they will not be the most impacting factor in your financial life. If you are not ready to buy a home or to make a large investment into your business the interest rates will not change that very much.

If you are ready to take out a loan, this may be the time. However, if you have other loans this may be a better time to refinance your current debts remembering only if you consider all of the factors in your loan and new loan. Keep in mind interest rates for your loan may affect your finances, but they are not the greatest factor to forge your wealth.

Author: Papa Foxtrot

Most of my life I was careful with money and learned where I should invest it. I was very lucky to have parents who taught me financial literacy when I was young. Unfortunately, I am very lucky because many people lack the financial literacy I know. The purpose of Forge Your Wealth is to teach people who are just starting out in life how to obtain their wealth or anyone who just realized they may need to learn more to handle their finances. I currently have a PhD in biochemistry, just started a job in industry (will not disclose where exactly for personal and professional reasons) and am currently married to the love of my life. I am one of the lucky few people in America who graduated with no student debts, my wife was not. Over the series of a little over 3 years we paid for our wedding with no debt and paid off her federal student loans.

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