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Why Fed Rate Hikes Will Have Little Impact On Borrowing Costs

Updated: 03/26/2022 by Financial Samurai 23 Comments

After three years, the Federal Reserve has finally begun hiking rates to help stem rising inflation. With the latest 7.9% inflation print, inflation is now at a 40-year high.

The Federal Reserve has telegraphed it will hike the Fed Funds rate 6-7 times over the next 12 months. Therefore, we could easily see 1% – 1.75% higher Fed Funds rates in the near future.

The Fed is behind the curve when it comes to hiking rates. And that’s understandable. The Fed would rather be a little too slow in hiking rates than a little too fast in order to help our economy survive a pandemic.

Put another way, which would you rather have, higher inflation and a stronger labor market, or lower inflation and a weaker labor market? The former is usually preferred. In an ideal world, the Fed would love to have 2%-2.5% inflation and 3.5% – 4% unemployment levels.

But the reality is, the upcoming Fed rate hikes will have a negligible impact on your finances, especially if you have been a regular Financial Samurai reader. Fed rate hikes won’t make borrowing costs that much greater. Therefore, for those of you who like to take out credit card debt, auto loans, student loans, and mortgage rates, I wouldn’t worry too much.

Let’s break down how Fed rate hikes will affect borrowing costs for each category.



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Negative Real Mortgage Rates Means Don’t Pay Down Extra Principal

Updated: 04/10/2022 by Financial Samurai 51 Comments

As a homeowner with a mortgage, the holy grail is having a mortgage rate below the 10-year bond yield. When you have this situation, it’s like living for free and you should not pay down extra principal. If you had the money, you could invest an amount equal to your mortgage into a 10-year Treasury bond. The interest income can then be used to pay your entire mortgage interest.

The second best situation is having a negative real mortgage rate thanks to inflation and low rates. In such a scenario, although you can’t technically live for free, from an inflation-adjusted standpoint, you kind of are. You shouldn’t be in a rush to pay down debt.

To see if you have a negative real mortgage rate, take your mortgage rate and subtract it by the latest inflation rate. If the percentage is less than zero percent, then you have a negative real mortgage rate. If you have a negative real mortgage rate, you should also slowdown or stop paying extra principal because you’re borrowing free money.



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The Average Credit Score In America Is Now Excellent

Updated: 08/09/2021 by Financial Samurai 58 Comments

The average credit score in America is now 710 according to Experian. Back in 2019, the average credit score was 703.

In other words, during a global pandemic, the average American improved their wealth and their financial health. Not only has the average credit score in America improved, the average saving rate has also improved from 6% to over 10%.

The Average Credit Score In America Is Now Excellent

When the U.S. saving rate surged in 2020 to a high of 32%, so did lending standards.

Lending Standards Are Tightening

During a previous mortgage refinance in 2019, my loan officer said that he hadn’t worked with a borrower with under an 800 credit score in over two years. I was surprised to hear this because I clearly remember banks offering the best refinance rates when you had at least a 760.

At the beginning of my refinance process, the mortgage officer asked whether I had over an 800 FICO score. I told him I thought so. But I felt like I had been caught in a lie because I didn’t know for sure.

However, if I had said “no,” I felt like he would have hung up on me. He gave me this “you better not be wasting my time” vibe.

With the mortgage industry even tighter today thanks to so much demand, borrowers must really have their financial ducks in order to get the best rate.

For those interested, let’s review the fundamentals of the credit score.



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Can Your Finances Withstand A Fed Rate Hike?

Updated: 07/09/2021 by Financial Samurai 62 Comments

Can your finances withstand a Fed rate hike? The Fed Funds Rate (FFR) is at 0% – 0.25% to help combat the recession and global pandemic. However, eventually the Fed will start raising rates again as inflation picks up.

In fact, the markets are now forecasting three Fed rate hikes by the end of 2023. This is a reasonable assumption since the 10-year bond yield is around ~1.5%.

Fed Rate Hike Expectations through 2023


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Destroy Debt Quicker: An Easy And Painless Way To Be More Free

Updated: 02/16/2021 by Financial Samurai 57 Comments

A fun and easy way to pay down debt quicker

Do you want to destroy debt quicker? You’re in luck because I have the best way to destroy debt quicker and boost your wealth faster.

If you haven’t noticed, we live in a consumerism society where we are bombarded by advertisements that compel us to spend on things we don’t need. Some things are definitely worth spending up on. But for everything else, save your money.

Like many people, I have debt. Although my debt is tied to property, which tends to appreciate over time, it’s still debt that I plan on getting rid of by 2027. I don’t have any revolving credit card debt because their interest rates are absurdly high.

Earlier this year, I got rid of $815,000 of debt by selling a rental house for roughly 30X annual gross rent. I don’t miss the rental income because I don’t miss the $3,400 monthly mortgage, the $23,000 in annual property tax, the $3,000 in annual maintenance, the $2,000 in annual insurance, and pain in the ass tenants.

Despite the large pay down, I still have about $1,000,000 in debt spread between my primary residence and my vacation rental in Lake Tahoe. Simple math states that if I can pay down $100,000 a year, I will be debt free in 10 years.

Here’s an easy strategy for how I plan to get there relatively painlessly that I recommend you follow as well.



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Pay Down Debt Or Invest? Implement FS DAIR

Updated: 02/11/2022 by Financial Samurai 103 Comments

The decision to pay down debt or invest is a personal one. It depends on a lot of factors such as risk tolerance, your number of income streams, liquidity needs, family expenses, job security, investing acumen, retirement age, inflation forecasts, and bullishness about your future in general.

I’ve had hundreds of people ask me whether to pay down debt or invest over the years. As a result, I came up with the Financial Samurai Debt And Investment Ratio, or FS DAIR for short back in 2014. Despite interest rates plunging since then, the FS DAIR framework still holds up strong.

The FS DAIR formula for deciding whether to pay down debt or invest is as follows:

Debt interest rate X 10 = percent of cash flow after living expenses allocated towards debt pay down

In other words, if you have a mortgage with an interest rate of 3%, utilize 30% of your monthly cash flow after living expenses each paycheck to pay down debt. Invest the remaining 70% of your cash flow based on your investment preferences.

If you concurrently pay down debt and invest, it’s very hard to lose in the long run. Ultimately, it’s best to be debt-free when you retiree or no longer have the desire to work.

As the CFO of our own finances, it’s up to us to figure out the most efficient use of capital. With FS DAIR, you will approach paying down debt or investing in a rational manner.  



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How Student Loan Forgiveness Can Cost You A Fortune

Updated: 03/21/2021 by Financial Samurai 48 Comments

After publishing my post on actions to take in a rising LIBOR environment, it dawned on me that besides refinancing your adjustable rate mortgage, you should also consider refinancing your student loans as well, if you have any. It feels like a lifetime ago, but I used to have ~$40,000 in business school loans that were paid off in 2008. Student loan forgiveness can actually cost you a fortune. 

During my time, there was no such thing as student loan forgiveness. Come hell or high water, you had to pay back what you owed with interest. You also couldn’t go straight to the corner office without paying your dues either. As our country has grown wealthier, softer, and more focused on instant gratification, student loan borrowers have pressured the government into giving them more options and it’s worked! 

Here are some various options borrowers have to repay their loans and how student loan forgiveness can actually end up costing a borrower more. I had no idea there were this many choices. I’m hoping by the time my kids go to college in 20 years, tuition will be free or highly subsidized, just like it is in Europe, Asia, Canada, and the rest of the world. It’s fun to have someone else pay!



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The Best Strategies To Get Out Of Debt And Become Happier In The Process

Updated: 03/21/2021 by Financial Samurai 58 Comments

Out of debt with not a care in the world

Let’s look at the best strategies to get out of debt. Once you get out of debt, you will likely become happier because you will feel less financial burden.

I graduated from business school in 2006 with roughly $55,000 in student loans. Although $55,000 is a lot to pay off, I was already a “debt veteran” by then. What’s another $55,000 in student loans when I was already leveraged over $1 million dollars to buy my first properties in 2003 and early 2005?

I didn’t need to take out student loans, but I decided to conduct some financial arbitrage. The maximum amount one could borrow through a Stafford Loan at the time was $18,500 a school year at an interest rate of 2.75%-4%.



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Measure Your Financial Security By Calculating Your Debt-To-Cash Ratio

Updated: 09/26/2021 by Financial Samurai 65 Comments

The best way to measure your financial security is by calculating your debt-to-cash ratio. Having a lot of debt lowers your financial security. Whereas having a lot of cash increases your financial security.

The lower your debt-to-cash ratio, the strong your financial security and vice versa. Using debt to buy a house that is appreciating in value is great. But using debt to buy a house when it is depreciating could cause problems if you don’t have enough cash on hand.

Your Debt-To-Cash Ratio

One of the reasons why I want to rebuild my cash reserves back over $100,000 is because of financial risk. With two rental mortgages to pay and no steady job, having less than $100,000 feels irresponsible. Further, I’ve got two young kids to take care of.

Theoretically, I could lose all my tenants and therefore have to shoulder both mortgage payments on my own. In such a scenario, because of property taxes, an HOA fee, maintenance, and mortgage payments, $100,000 would be exhausted in 12 months.

Going off a gut feeling to determine how much cash to have is OK. But it would be nice to formalize a debt-to-cash ratio to see at what level debt is too much.

Because of excessive debt, way too many people got their heads blown off during the last financial crisis. 

Today, we once again see plenty of people borrowing from their home equity to buy things they don’t need. It’s so funny how quickly we forget about the risk of having too much debt!

Although the economy is recovering from the pandemic, reaching herd immunity is nowhere near certain.



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Household Debt Composition Mix Over Time: Student Loans Way Up

Updated: 02/16/2021 by Financial Samurai 45 Comments

The NY Fed, Federal Reserve, Bureau of Economic Analysis, and Morgan Stanley put out a series of fascinating household debt charts we should all be aware of. The charts show the household debt composition mix over time.

Excessive debt is what makes extremely rich people go broke. Leverage is what crushed the economy once the music stopped playing in 2008. But boy is debt nice when properly used to grow one’s net worth in a bull market.

Now that the economy is on the path to recovery, U.S. debt levels are reaching record high levels. We must use debt responsibly.

Everybody should have the goal of being debt-free by the time they are no longer able or willing to work, no matter how low the interest rate. Having enough passive income to cover all your expenses while owing nothing to anybody is financial freedom at its finest.

Let’s take a look at the household debt composition charts and see if we can uncover some wisdom. 



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