Falling Interest Rates Provide Opportunity For Re-Financing Advantage

By David Christianson, BA, R.F.P., CFP, TEP

Last week's 50 basis point drop in interest rates, now reflected in the major banks' prime lending rates, may spell opportunity for your clients (and you) to reduce your borrowing costs.

The chartered banks' prime lending rate, the rate at which they lend money to their most creditworthy customers, has gone from 5.25% one year ago to 2.5% today. This means that if you have a line of credit at prime plus 1% with an average balance of $10,000, your annual interest has decreased from $620 to $350.

A $100,000 variable rate mortgage might have cost about $5,000 in annual interest last year, while this year you will pay about $3,700.

Variable rate loans are the easy ones. Any loan that is tied to the prime rate, like a line of credit or a variable rate mortgage, has automatically adjusted its interest rate to give you the saving. Consumers don't have to do anything with those loans.

If the credit card balance is not paid off every month, then interest is charged (retroactively to the date of purchase, often) on the outstanding amount. If this happens once, then interest is charged until two successive months go by with a zero balance. The interest rates are usually in the range of 18% or more.

Electronics and furniture companies often have loans charging as much as 24% or more. This is something many consumers don't understand. If someone accepts the great offer of "no interest until 2010î, then they better make sure they pay off the balance before the first payment is due.

Obviously, paying off these credit cards and consumer debts is where the greatest potential interest rate saving exists. Debt consolidation - either by setting up a fixed term loan or a line of credit - can save hundreds of dollars of interest each year, or even thousands if a person has large debts.

If you have high interest rate, non-deductible debt, then now is a great time to talk to your bank or credit union (or their competitor) about how you can save on interest costs. Don't let them talk you into more loan than you need, though, and don't let cheap money convince you to go further into debt.

"Re-pricing initiativesî

Here's a funny thing - the banks' actual cost of money has gone up over the last 18 months, in spite of all its declines in interest rates. They are not deemed as creditworthy as they were a year ago, and their own credit is much tighter. This means the banks are scrambling to provide these loans at low rates and still make a profit. Many of the banks are undergoing what they euphemistically call "re-pricing initiatives", which means raising the rates on existing lines of credit.

At least two major banks are sending out letters "advisingî customers of an increase in their interest rates, relative to prime.

I was pretty perturbed last week when I got a letter from my bank's head office letting me know that my line of credit with being raised from prime plus 1% to prime plus 3%, without consultation or reason. Although it will end up being cheaper than it was a year ago, I don't want it to increase and was extremely put off by the way they approached it. My bank manager is sympathetic and is encouraging me to continue to harass the head office person who had the gall to sign the letter. He left no contact information, but I've been able to track him down and clog up his voice mail.

New borrowing

I'm going to say two contradictory things here. The first is that if the recession has a person worrying about job security, it's likely not a time to borrow more money, just because interest rates are low. It's a time to build up cash and make sure that any existing loan payments could be handled through an interruption in income.

The contradiction is that this is theoretically the ideal time to be borrowing to invest. When you borrow to invest, the interest you pay is tax-deductible. The time to buy investments is when they are low. Whether a person is inclined to purchase an investment property to rent out or invest in the stock market, there's no doubt that prices are low. However, an important consideration is obviously whether prices are going to go lower and, especially, whether they will stay low for a long period of time.

My only point in bringing this up is that people were quite anxious to borrow money to invest two years ago, when the stock markets were 40% higher and the prime rate for borrowing was 2.5% higher. The tough part about buying low is that you actually have to do it - you have to buy when things look really bad, which they do now, and when any sensible person would be running for the hills.

Now, having gotten your attention, I am not recommending that anyone run out and borrow to invest, although I would be less likely to talk them out of it now than I would have been one year ago.