People are getting really excited because the Fed cut the interest rate for the first time in several years. I don’t remember this kind of buzz during the last cuts, or maybe I wasn’t paying attention. It honestly makes me concerned that people are this excited over a relatively small interest rate cut.
Concerns
What concerns me is not just the excitement, but also the questions and subsequent plans. Here’s a recent conversation:
Q: Should I refinance now?
A: What’s your current interest rate?
Q: 2.75%, I was thinking about refinancing because I have equity in my house and want to do some things with the house. Is that a good idea?
A: You’re wanting to go from a 2.75% rate to 6% just for a couple home projects or are you doing something else as well?
Q: Yeah, just a couple home projects. Nothing else planned. So do you think it’s a good idea?
A: No
Interest Rate Tradeoff
Trading a 2.75% rate for a 6% rate just to access $50,000-$75,000 for a couple projects isn’t a very good deal. Great deal for the lender, bad deal for you. It’s exactly why everyone is getting notices from their lenders that “now may be a good time to refinance.”
The lenders want you to do this and lure you in with “ideas” about what to do with the money. Ideas like home projects, a kitchen remodel, paying off car debt, etc.
Here’s the truth: it’s fools gold and comes with a massive cost nobody should incur.
For context, a $700,000 loan with 2.75% interest is $2,858 per month. A $700,000 loan at 6% is $4,197 per month. You don’t have to be a math genius to know this is a bad idea. Plus if you pull money out, you’re also paying on the money you took out.
We’ve all heard the expression about “money burning a hole in your pocket.” This is what I’m afraid is happening with the most recent interest rate cut and the coverage it’s getting throughout media outlets.
When people have money that has been difficult to access (like home equity), and it becomes easier to access with lower interest rates, it’s a real danger zone. Even though the rates are lower than they have been in the past couple years, they still aren’t close to the low rates from the several years before that.
Related: Leveraged Debt: The Good, The Bad, & The Ugly
What To Do
For someone with an interest rate on their home of three percent or less (or even four or five percent), they are winning that part of the money game. Making a big move to access some equity and then ending up with a rate over six percent makes little sense.
It’s one thing if that money was going to be used to make a lot more money, but if it’s just for a home project or to have extra cash, it’s a really bad idea.
It’s sacrificing the future for a momentary gain that will only feel good for a brief second. Then the reality will hit that you restarted the clock on your mortgage and will pay a much higher rate for a longer period of time.
It’s tempting to get the quick cash, but avoid a mistake like this. You’ll be paying the price for years to come and put yourself in a hole when you didn’t need to.
For credit cards, my advice always has been, and always will be to stay out of consumer debt. It’s one of the biggest wealth inhibitors. A half percent rate cut on a 20 percent or more interest rate won’t make much of a difference at all, so don’t try to hack this. Just stay out of it and you’ll be looking good.
