No Fear of Falling

By Daniel Kadlec

Interest rates are falling to historic lows yet again, making it harder for safety-minded investors to find decent yields. But there's a windfall in this trend for homeowners--and the overall economy. Believe it or not, it's time to refinance again. Even if you took out a fixed-rate mortgage as recently as January or caught one of the best deals in several generations when rates plunged last fall, you may be able to shave another half-point off your rate. And if you have an adjustable mortgage, now is the time to lock in a fixed rate before it rises.

Meanwhile, with bond yields so low and bond prices likely to fall as rates rise, it's time to dump long-term bonds and bond funds. And get rid of any money-market holdings in your 401(k) and IRA accounts in favor of safe investments that pay higher yields.

Let's start with mortgages. The yield on the 10-year Treasury bond has been falling all year and last week hit a 44year low of 3.55% before ending the week higher. Mortgage rates have followed, and for conforming mortgages (those under this year's jumbo threshold of $322,700), the average 30-year fixed rate last week sank as low as 5.58%. That's down from just over 6% in October, reports mortgage-research firm HSH Associates. Deals on fixed-rate 15-year mortgages are even sweeter, having cracked the 5% barrier for the first time.

Half of the nation's $6 trillion of mortgage debt could be refinanced now at a rate that would reduce monthly payments enough to recover all expenses within a year, estimates Mark Zandi, chief economist at Economy.com This is great news on both large and small scales. For homeowners it means more available cash to spend on things or pay down debts.

For the economy it means the main prop beneath consumer spending for the past few years is as sturdy as ever. When homeowners lower their monthly interest expenses--in some cases even as they boost their debt through cash-out refinancings--they are able to keep spending. A new wave is already rising. The number of refis has surged in recent weeks, topping the weekly record of last fall by 29%.

Be prepared to deal with the rush. To avoid paying for the blown deadlines and other mistakes of harried bankers, keep track of things like the good-faith estimate of costs and the HUD-1 statement of expenses that you will get from your lender. (Make sure the numbers on both forms are about the same.) Consider refinancing with your existing lender, which, to avoid losing business, may agree to reset your rate for as little as a few hundred dollars in handling costs. With your current lender, you would avoid the risk of getting stuck in a paperwork jam at a new place, which might not approve your loan before the typical 60-day lock-in period expires.

To make a refi worthwhile, you generally need a new rate at least a half-point lower than your old rate. Remember: even though you may not have out-of-pocket expenses, a refinance involves costs, including origination fees and title searches, that typically total 1% to 2% of the mortgage. You can pay those expenses up front or through a higher loan amount or higher interest rate. No matter how you pay, if the monthly savings do not cover the expenses within three years, stick with your current loan.

The recent decline in rates has driven yields on short-term investments to historic lows, and many expect the Federal Reserve to cut its benchmark federal-funds rate in May to 1% from 1.25%. This is a grim development for anyone who seeks a decent yield but wants to keep cash out of harm's way. Money-market mutual funds now yield less than 1%, on average. After tax, that barely covers fund expenses, let alone inflation.

Here's a better choice: most 401(k) plans offer stable-value funds, which buy a mix of insurance contracts and high-grade government and corporate debt, with protections that keep their value from fluctuating much. They do occasionally lose value and so are a touch riskier than money-market funds but are yielding 4% or more.

Bonds have been winners for three years as investors have sought safety amid war jitters and a sputtering economy. But with yields so low, bonds--and especially Treasuries--have become risky. When the economy shows signs of life or the war jitters fade, money will flood out of Treasury bonds, driving prices lower and yields higher. The bond price--your principal--would fall 12.5% if yields rose 2 percentage points. Buying T-bonds today is like buying stocks in 2000, when they were in peak demand.

A better option is a diversified junk-bond fund like Northeast Investors Trust, whose high yields should attract money away from Tbonds, or a fund like American Funds Capital Builder, which buys stocks that pay dividends. Sometimes you have to move against the herd. Now is one of those times.

You can e-mail comments to Dan at danielkadlec@aol.com