Here's our situation.
Lower interest rates won't do much to kick-start business. Low rates will lower borrowing costs but business has plenty of production capacity. If your company needs some technology, check the auction houses.
That means jump-starting the economy is up to us, the Global Consumer Heroes. It's our spending that drives economies around the world.
The only problem is that we haven't got the cash.
Income gains from raises, if anyone gets them at all, are likely to be offset by lost jobs and paychecks.
So where do we find the money?
By restructuring our debt. By reducing our interest expenses.
It's real, it's powerful, and it will increase spending power.
Skeptics should consider this example. Suppose you are a relatively young couple that bought a house in 1994. With a joint income of $40,000 you were able to buy an existing house at the national average resale price of $110,000. You made a down payment of $10,000 and assumed the biggest debt of your life, a $100,000 mortgage at 7.5 percent for 30 years. It had a monthly payment of $699.
Qualifying for the mortgage was a breeze because you had virtually no credit card debt and no car loans. Those were the Good Old Days, before children.
Today, you're weighed down by debt. The house is worth $147,000 (it rose with the national average) and the mortgage has been paid down to $91,300. So your equity has grown from $10,000 to $55,700. This makes your house the best investment you ever made. Unfortunately, you now have credit card debt of $8,000. It requires a minimum payment of $160 a month. The balance just crept up on you, a little like weight gain. You also have two car loans that cost another $608 a month. The $30,000 you borrowed two years ago at 8 percent for 5 years is now down to $19, 400.
Your gross income has risen by $11,400, right in line with the national average. Unfortunately, the increase is less after taxes ($614 a month) than your payments on auto loans and credit card minimum payments ($768 a month). So you're in a squeeze, you're worried about your job and everyone from the President on down is telling you to lead a normal life and spend lots of money.
What do you do?
Restructure your debt.
You look for a bargain refinance rate and you refinance with enough cash out to pay off your credit cards and your car loans. When you roll your $91,300 mortgage balance, your $19,400 car loans balance, and your $8,000 credit card balance into a new $118,700 home mortgage at 5.5 percent, your mortgage payment actually drops to $674 a month, the other payments disappear, and you suddenly have $793 a month of new spending power in your checking account. If you can't wait for a 5.5 percent rate, you might do it at 6.0 percent and your new spending power will be $755 a month. The table below shows the changes.
Can everyone benefit as much as this example? Some will benefit more, some less, some not at all.
|Restructuring A Consumer|
|Increase in Income||NA||$11,400||$0|
|After Tax Increase||NA||$7,364 or $614/month||$7364 or $614/month|
|Total Debt Service||$699/month||$1,467/month||$674/month|
|Change in Debt Service||NA||Up $768/month||Down $793/month|
|Change in Purchasing Power||NA||Down $154/month from 1994||Up $793/month from today.|
|Source: Author calculations|
You don't really want to know. Since you have to pay the employment tax (7.65 percent) and Federal Income taxes (28 percent), 35.65 percent of any wage gain disappears. You would have to increase your income by $14,776 a year to net $793 a month---that's a pay increase of 29 percent. Not a likely prospect.
Is this a free lunch?
Absolutely not. The liberated income comes at the expense of extending all your debt for 30 years. In addition, some of the interest savings will come from the pockets of retirees.
Scott Burns is the retired Chief Investment Officer of AssetBuilder, the creator of Couch Potato investing, and a personal finance columnist with decades of experience.