Luke Delorme | Money Talk: Time to re-finance personal debt?

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GREAT BARRINGTON — After having gradually increased over the past few years, interest rates are once again falling.

The average 30-year, fixed-rate mortgage in the U.S. sat at 3.75 percent at the end of July after reaching nearly 5 percent in December.

These average mortgage rates are historically low. Since Freddie Mac started collecting data in 1971, the average 30-year mortgage rate has been just over 8 percent. (The average 30-year rate hit a nadir of 3.31 percent in 2012.)

Other rates on student loans and credit cards are likely to decline as well.

Concerned about potential sluggish economic growth, the Federal Reserve recently cut interest rates for the first time since 2008. So, should borrowers consider re-financing and/or consolidating debt?

First, a note of caution: It is impossible to determine the future direction of interest rates. Although interest rates are falling today, it could easily reverse course next week. What matters for someone considering a re-finance is the current interest rate.

In general, there are four main considerations when determining whether to re-finance mortgages, student loans, credit cards or any other debt. Consider the following:

- Is the new potential interest rate lower than your existing rate?

Unless the potential interest rate is lower, now is probably not the time to re-finance. Ideally, the new interest rate will be at least 0.5 percent lower than the existing interest rate.

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- How long will the new loan last compared to the old loan?

You may choose to re-finance in order to reduce the length of a loan in addition to lowering your interest rate. Or, you may actually choose to increase the length of the loan in order to reduce monthly payments.

- How will your monthly payments change?

Remember that higher monthly payments might be okay if the length of the loan is significantly reduced. For example, if you re-finance a mortgage with 20 years remaining to a new, 15-year fixed mortgage, the monthly payment might be slightly higher, but the end result will be better.

- How does the re-finance fit in with your broader financial circumstances?

If you are going to lower your payments, think about what you'll do with the extra money. If you're going to shorten the term and increase payments, how will you come up with the extra monthly cost, and what will you do once the loan is paid off? These additional considerations are often the most important driver of whether to re-finance.

Re-financing a mortgage or other debt will make sense when the upfront cost is more than covered by future savings. This can be hard to determine when you're looking at switching from a mortgage with an odd number of years remaining to a more standard length, such as 15 years.

One of the more powerful financial decision-making tools is called "net present value" or NPV. Although the mechanics of NPV are too in-depth for this article, a mortgage broker or financial adviser should be able to help you construct such an analysis. You can also use a spreadsheet or one of many free online calculators.

Managing debt by re-financing or consolidating can be a simple and effective way to improve your financial circumstances. As interest rates fall, think about whether you have higher-interest rate debt that might be worth re-structuring.

Luke Delorme is director of financial planning at American Investment Services in Great Barrington. He can be reached at luked@americaninvestment.com. Past performance is no guarantee of future results. This information should not be considered investment advice or a solicitation to buy securities. A professional adviser should be considered first before implementing the options presented.


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