It’s quiz time again. A chance to test your personal financial skills against the gyrations of the market and the funny ways that bank rates have been bouncing like a yo-yo.
If you took this test back at the start of the year, the correct answers would be different. Why? Because interest rates were different. Plus, the economy now looks weaker than it did in January.
Ready? Get all the answers right and you’re a financial wizard. Anything less than three correct answers sends you off for more study.
Q-You’re shopping for the cheapest $80,000 mortgage to finance a new home. You’ve noticed that 30-year fixed rates have fallen from an average of 9 percent to 7.5 percent over the past six months; the average 15-year fixed rate is now a shade below 7 percent, and adjustable rates (ARMs) are averaging 5.72 percent. Your total household income is $75,000, you have little debt and you probably will stay in the house until the year 2000. Which mortgage should you take?
A-The 15-year mortgage, largely because you can afford it. The monthly payment on the 30-year mortgage would be $560. But you can handle up to $1,750 a month, so the 15-year mortgage payment of $719 would be no sweat. Adjustable rates would make sense only if you planned to stay in the home for three years or so. Six months ago, you might have thought about an ARM because it was relatively cheaper then.
Q-You’re dickering between financing a $16,000, four-year new car loan through an auto dealership, or getting a home equity line of credit for the same amount. The dealer offers a 10.6 percent rate, and your bank’s home equity rate is 9.25 percent. What’s the smartest step to take to obtain the cheapest borrowing cost?
A-First, shop around some more. The banks’ average new car loan rate is 9.6 percent, or a full percentage point lower than many dealers’ rates. The upside to a home equity line is that the rate is usually tied to the bank’s prime rate. It may drop if the Federal Reserve lowers interest rates to stimulate the faltering economy. That’s the reverse of how things looked at the start of the year.
The downside risks today are two: The bank’s home equity rate is an “introductory” rate that will probably jump to 10.5 percent or thereabouts within 12 months. Plus, if you default on payments, the bank could grab your house.
Bottom line: Your four-year auto loan would cost you $3,700 in non-deductible interest at the car dealer vs. $3,300 at the bank. A home equity line would cost you just under $3,500, but the interest could be tax deductible. The figure assumes the 9.25 percent discounted rate lasts a year and the real 10.5 percent rate doesn’t budge for the following three years.
Q-You have three credit cards on which you owe $3,000 each. One card has a fixed rate of 18 percent with an $8,000 credit limit, the other two have variable rates of 15 percent and 12 percent, respectively, with $5,000 limits. You want to consolidate the $9,000 on the cards. You’ve also decided to get rid of two of the credit cards. Which one should you keep?
A-Shift $2,000 from the fixed-rate card to the 12 percent card. Pay off the remaining $1,000 as quickly as possible and close out that account. Why? You cut interest expenses by one-third when you move the balance. From there on out, pay off the 15 percent card and get rid of it, too. You would not have done this when rates were rising, because the variable-rate cards could have gotten more expensive. Now, they could become cheaper.
Q-You’re thinking about refinancing your current adjustable-rate mortgage, which started out at 5.5 percent in 1993 and now is up to 10 percent. The balance is $65,000. Assuming you and your mate are forty-something and plan to remain in the house forever, what kind of refinancing deal is better-a fixed rate or an ARM?
A-The fixed rate. Not only will you cut your interest rate by 2.5 percent, but you’ll permanently set the rate. Your answer would have been different in January, when it looked as if fixed rates were headed into double digits.
