Now Is the Time to Shrink Your Borrowing Burden The days of falling rates are coming to an end, so don't wait to cut your interest costs.
By Carla Fried

(MONEY Magazine) – The big news for borrowers in 1994 is that you can no longer bank on steadily falling interest rates. "I don't see a major change in rates in '94, but any movement will be to the north," says David Lereah, chief economist at the Mortgage Bankers Association in Washington, D.C. Indeed, a warming economy has already pushed the 30-year fixed-rate mortgage -- which hit a low of 6.8% in October -- back above 7%. The news isn't all glum, however. The opportunities for bargain-basement borrowing that prevailed during 1993 won't disappear overnight. And while mortgage rates have blipped up, rates on home-equity lines (HELs) are expected to hold steady, and credit-card rates should actually fall a bit further as purveyors of plastic vie for a spot in your wallet. Still, if you are in the market to borrow money, there's no time like the present. Here are three debt- defying moves that you can make right now: -- Refinance your mortgage. Incredibly, about 8 million homeowners hold more than $550 billion in 30-year fixed-rate mortgages with rates above 9.5%, which is more than two points higher than today's 7.2% average, according to an estimate by Lereah. If you are one of these high-rate Van Winkles, wake up! Experts say that you will save money if you lower your rate by only one-half of a percentage point. So even if you were one of the alert homeowners who refinanced in late 1992 or early last year, you need to pull out the calculator one more time and consider refinancing for the second or third time. The basic rule of thumb is that you must stay put long enough to recover the expense of refinancing (including any up-front points and closing costs) through lower monthly payments. To determine how long that will take, subtract the monthly payment on the new mortgage from your current monthly payment. Next, divide the refinancing costs by the monthly savings. The number you come up with is roughly how many months it will take to break even. For example, if you pay $3,000 in points and closing costs to lower your monthly payments by $200, it will take 15 months to recoup. Part of your decision to refinance involves choosing between an adjustable- and a fixed-rate loan. Homeowners who are sure they will move within the next four to five years can keep monthly payments to the absolute minimum by choosing an adjustable-rate mortgage (ARM). The smart move is to steer clear of the most common type -- one that adjusts annually. Despite temptingly low teaser rates of 3.5% or so, one-year ARMs leave you too vulnerable to rising rates. Instead, consider an ARM that adjusts every three years, called a 3/3. The current average rate is 6%, so even if the rate jumps the standard maximum of two points, the most you'll pay for years four through six is 8%. That means your total costs with the 3/3 ARM are certain to be lower than with a / fixed rate for the first five years of your loan.

Instead of refinancing to lower your monthly payments, you can choose to shorten the term of your loan. The popularity of 15-year mortgages has tripled during the past three years, mainly because borrowers like the idea of paying off the loan more quickly and saving thousands in interest costs. As appealing as that sounds, however, it usually makes sense only for homeowners who want to retire all their mortgage debt before they retire -- or before they face the burden of a major obligation such as college tuition costs.

For everyone else, the traditional 30-year loan is the better choice, says Frazier Bell, a mortgage lender in Charlottesville, Va. and author of How to Get the Best Home Loan (John Wiley & Sons, $14.95). For one thing, the longer term means lower payments (at current rates, the difference on a $100,000 loan is about $200 a month). That gives you more cash for everyday living, emergencies or investing. And if you're eager to reduce your indebtedness and find yourself with some extra cash on hand, Bell says, send in the money. Making just one extra monthly payment a year will enable you to polish off a 30-year loan in 24 years, saving $34,516 in interest costs on a $100,000 loan at today's average rate of 7.2%. -- Open a home-equity credit line. Home-equity lines have several things going for them in 1994. For one, most lines are pegged at 1.5 to two percentage points above the prime lending rate, which is currently 6%. Bankers were slow to drop their prime rates even as other rates fell during 1993. And industry analysts believe bankers will keep the prime at its current level evenif other rates rise slightly. That means today's 7.5% average HEL rate should hold fairly steady throughout the year. Another plus: Interest payments on HELs of $100,000 or less are usually tax deductible. And President Clinton's income tax increases have made deductions more valuable now than at any time since the Reagan tax cuts of 1986. Deductibility widens the advantage of a 7.5% HEL rate over the nondeductible average credit-card rate of 17.9%. Finally, thanks to fierce competition among banks, you should be able to find a lender willing to waive the typical HEL up-front costs of $600 to $700. Ross Levin, a Minneapolis financial planner and president of the International Association for Financial Planning, suggests that you take advantage of a no- cost offer to set up a home-equity line of credit now, even if you don't need any cash. "It's a great security cushion if your financial situation changes," he says. Once you have a credit line, however, be careful how you use it. Planners recommend that you avoid borrowing more money than you will be able to pay back within three years or so. The rate on your HEL will rise whenever the prime rate does, with no annual cap and a lifetime ceiling of 18% to 24%. While the prime isn't expected to be a big mover in 1994, you don't want to be caught with a large HEL balance during a post-1994 upward interest-rate spiral. -- Switch to a low-rate credit card. Even if other lending rates climb during 1994, the outlook is for credit-card rates to continue the slow decline that saw the average rate fall from 18.5% to 17.9% in 1993. Robert McKinley, president of RAM Research in Frederick, Md., expects the national average to fall a full point in 1994. And he believes more cards will be available at 10% or below. "Savvy consumers are forcing issuers to be more competitive," he says. "And that will mean more low-rate cards appearing this year." But don't wait for your card's rate to drop -- find a low-rate card now. If you are one of the 70% of cardholders who carry a monthly balance -- $2,200 is the typical burden -- and you pay the national average rate of 17.9%, your annual interest bill is a hefty $396. Switch to a card with a 10% rate and you'll save $176 a year. The only catch is that some issuers set higher credit requirements for low-rate cards. For $5, the Bankcard Holders of America (703-481-1110) will send you a 26-page pamphlet that discusses the qualifying standards that low-rate issuers use. For example, lenders frown on applicants who are carrying over monthly balances on more than four credit cards. Therefore, you may want to pay off some of your high-rate balances before you apply for a new card. So what's the best resolution you can make and keep for 1994? Don't borrow any money at double-digit rates. After all, in this or any other year, cutting your credit costs is one financial move that is guaranteed to put money in your pocket.

CHART: NOT AVAILABLE CREDIT: HSH Associates and Bank Rate Monitor CAPTION: Take a good look at today's bargain rates Lending rates declined sharply during 1993 to the lowest levels in many years. But some key rates have begun to creep up.