`Neither a borrower nor a lender be.”
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Though often attributed to Ben Franklin, the Bible or a wise neighbor your dad used to know, that advice was actually penned by William Shakespeare in “Hamlet.”
Polonius, a character who offered additional insights such as “to thine own self be true” in the play, was counseling his son on the perils of debt.
However, old Polonius wasn’t doing business in an era of adjustable mortgages with a 4.5 percent fixed rate for the first seven years.
The combination of historically low interest rates and the mounting financial pressures placed on families by a lingering recession have made this one of the more acceptable times to borrow.
Judiciously chosen low-interest debt that you can handle remains an integral part of an overall financial plan and can help free up money to be invested in stocks, bonds and money market funds. Come up with a personal strategy to assure you’ll never pay more than necessary.
Just don’t get carried away and think low-rate money is free money.
“The sad news about borrowing is that you still have to pay the money back,” warned Marilyn Capelli Dimitroff, certified financial planner and president of Capelli Financial Services Inc., Bloomfield Hills, Mich. “There’s a school of thought that with rates this low you should borrow as much as you can and invest it all, but remember that there are no guarantees.”
Borrow for items that add value, such home improvements, a second home, starting a business or investing, Capelli advises. Don’t borrow for a vacation, since even with low rates you’ll be paying interest on it for many years.
Facing high unemployment and squeezed budgets, many families must choose which credit source to tap first. Dimitroff’s first choice would be a home equity loan because most every homeowner qualifies to deduct the interest on it. Her least favorite debt instrument is the credit card, since it usually has a floor on how much it can fall, no matter what other rates do.
There’s some good news for students and their families in the form of dramatically lower rates on federal student loans.
On July 1, the rates on Stafford loans for the next 12 months decline to 2.82 percent from 4.06 percent for in-school borrowers. They’ll be 3.42 percent for borrowers currently making payments. Stafford loans are the largest source of student loan funds.
This presents an opportunity to consolidate existing loans.
“You can lock in the rate and extend the term of the loan, reducing your monthly cash outlay by as much as 50 percent, depending on your balances and the terms you pick,” explained Barry Morrow, chief executive of Collegiate Funding Services in Fredericksburg, Va. “As long as you have multiple federal loans, you qualify to get a consolidation loan.”
An increasingly popular source for family emergency money these days is the company 401(k) plan. About 85 percent of plans now have loan provisions, typically charging 1 percent over the prime lending rate.
There’s an initiation fee and you can borrow half of your account balance up to $50,000. You must repay in five years through payroll deduction or the loan goes into default. This feature was introduced to increase employee participation and as an emergency source of money for lower-paid workers.
But this isn’t the intended purpose of this important retirement vehicle.
“The number one drawback to a 401(k) loan is that if you quit your job or get fired, you must repay the loan immediately or it goes into default,” cautioned David Wray, president of the Chicago-based Profit Sharing/401(k) Council of America. “The defaulted amount becomes a distribution, so you must pay the regular tax on it, plus a 10 percent penalty.”
Low mortgage rates tempt homebuyers and owners considering refinancing, but some folks seem to be waiting for 0.0 percent financing like the car companies offer.
“Even though we’re at 45-year mortgage lows right now, my advice is not to try to time it to get the absolute lowest rate, since low rates can go away very quickly, as they did in 1994 and 1999,” said Steve Schwartz, president of Old Oaks Mortgage in Barrington. “I’m telling my borrowers that they should pull the trigger and lock in rates now.”
His clients use home equity loans as a way to avoid mortgage insurance, which isn’t deductible. They typically put down 10 percent on a home and also have a 10 percent home equity line at the prime rate. Under the proper circumstances, another valid use of home equity loans is to consolidate debt from high-interest credit cards. Just don’t “reload” with more card debt after you do that.
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