Updated in 2Q2017
LIBOR has risen dramatically since the end of 2015. The catalyst was the Fed raising the Fed Funds rate for the first time in years from a target rate of 0% – 0.25% to a target rate of 0.25% – 0.5%. But it’s surprising how LIBOR has risen by almost 1.4% while the Fed has only raised by 0.5% as of 2Q2017.
If you are in an adjustable rate mortgage where your initial fixed rate period will go variable within a couple years, you are going to be paying higher rates if you don’t refinance because ARMs are usually tied to LIBOR + a fixed margin.
Below is a snapshot of my mortgage refinance terms from early 2016. Notice how my 2.375% ARM rate is based off 1 Year LIBOR + a margin of 2.25%. Also observe how the math doesn’t add up: LIBOR at the time was 0.42% + 2.25% margin = 2.67% instead of 2.375%. In other words, lenders subsidize you for the initial 3, 5, 7, 10 year fixed term to win your business.
If my ARM were to float today, my 2.375% mortgage interest would actually jump to around 3.82% (2.25% margin + 1 Year LIBOR 1.57%). Although 3.82% isn’t particularly high in the history of mortgage rates, it’s still 60% higher than what I was paying. Everything is relative in finance.
If you refinance now, you will also re-lock a subsidized rate for your ARM, or simply get a higher, non-subsidized rate with a 30-year fixed mortgage. Check the latest mortgage rates online. Your goal should be to get multiple quotes for free, and then pit them against each other to get the best rate possible. This is exactly what I’ve done to get a 2.375% 5/1 ARM for my latest refinance.
So why has the spread between risk free rates and LIBOR widened so dramatically? According to Jeff Rosenberg, Chief Investment Strategist for Fixed Income at BlackRock, rising LIBOR isn’t a signal of credit stresses in the financial sector; instead, rising LIBOR is due to impending regulatory changes to U.S. money market funds (MMFs).
Jeff writes, “The reforms, adopted by the Securities and Exchange Commission in 2014, go into effect Oct. 14 of this year m. The new rules will change the structure of money market funds by moving from a fixed $1 net asset value (NAV) to a floating NAV for institutional “prime” money funds, and imposing potential redemption fees and suspensions in the case of some other MMFs.”
As result of the new rule, there’s been a large shift of money market funds out of prime funds and into government funds (prime funds invest primarily in corporate debt securities). “This uncertainty has fund managers increasing liquidity and shortening maturities as Oct. 14 approaches. The result is a decline in the supply of short-term (i.e., three-month) funding in the corporate financing market, and a rise in borrowing costs,” Jeff continues.
Confusing! The bottom line is that once again, thanks to government regulation of the free market, there is another kink in the system.
What Else To Do Besides Refinance?
1) Increase your savings rate. Higher interest rates dampen demand because it makes borrowing money more costly. The more cash you have, the less you need to borrow. The more cash you have, the more you have to lend. Short-term pullbacks are common with risk assets because there needs to be a recalibration of the yield spreads back to its historical range. There is NO RUSH to buy risk assets as a result. The S&P 500 and Dow Jones Index are near record highs in 2017.
2) Research higher income generating assets. As a retiree who paradoxically works his butt off and is therefore in a higher marginal tax bracket, I’m salivating at finally being able to build a sizable municipal bond portfolio that’s state and federal tax free. After buying stocks with a growth bias since the recession, my goal is to now shift the principal gains towards income generating assets as global growth slows.
It’s always important to focus on converting “funny money” into either a real asset that doesn’t go *POOF* in the next recession or a steady income generating asset. I know so many people who were paper millionaires during the 2000 dotcom bust who ended up with NOTHING but a tax bill for assets also worth NOTHING.
A) Conservative Muni Bond ETFs
MUB: iShares National AMT-Free Muni Bond ETF. It holds more than 2,750 various muni bonds with the top 10 of its holdings accounting for only 2.47% of total. 99% of MUB bonds have been awarded a credit grade of between A and AAA. 56.3% are rated AA.
I’m also focused on CMF, a California Muni Bond fund so I don’t have to pay state taxes on the income either. Check out your local state muni bond ETFs so you don’t have to pay state income taxes as well on the dividend proceeds.
B) Higher Yielding Real Estate Crowdfunding Investments
Real estate crowdfunding has opened up once unobtainable real estate investment opportunities to the masses. Multi-family property and commercial real estate have traditionally been available only to institutions and extremely high net worth individuals. Now that there’s RealtyShares and Fundrise, the two leading real estate crowdfunding platforms that have raised the most amount of capital and have allocated the most amount of capital, investors can now invest in various real estate deals with just $1,000 – $5,000.
I think real estate crowdfunding is one of the most attractive opportunities over the next 10 years. Being able to invest in the heartland of America where cap rates are 10%+ versus under 4% on the coastal cities is attractive.
3) Boost your Certainty Income. Because we are in a political and interest rate transition period, we have uncertainty. When there is this much uncertainty, investments tend to go nowhere. Therefore, it’s only logical to boost your “Certainty Income” through additional effort.
Now is the time to take that second job or add on another consulting client. Now is the time to launch your website to grow your personal brand. Build your book of business today for the potential fade. And if things turn out just fine in 2017, then you’ll simply have an extra income rocket booster by your side.
I’m finishing up a 3-month consulting contract with an SF-based insurance company this month, in the interview process with a health tech startup, sat down with the CFO and CMO of a potential partnership/acquisition last week, and just got back from a 1.5 day paid gig in Seattle with a large financial institution. Oh yeah, and then there’s publishing on Financial Samurai 3X a week, baby! Always be hustling and looking ahead for new opportunities.
Bullish Or Bearish Doesn’t Matter
Rising LIBOR is a short-term negative, but likely a long-term positive. There cannot be sustained higher rates if there isn’t a sustained higher demand for money. If the demand for money fades, so will LIBOR. Not only is everything relative in finance, everything is also rational in the long run as well.
It’s always nice when your investments act as a tailwind for net worth growth. Just know that it’s even nicer if you can build enough income streams so you aren’t reliant on your investments at all. Besides, active income is more enjoyable than passive income. Sitting back and collecting the digital Benjamins is not really fun or rewarding. Going out there and doing work that’s meaningful while earning is.
Updated in 2Q2017