Low Rates Are Not Here to Stay
The low interest rates of today may be no more long lasting than the 0% interest credit card intro offers. For many, the stock market is an attractive alternative to paying off low interest mortgage debt. After all, if someone can invest and get 6-12% in the stock market, why would someone want to pay down debt when the interest rates on such debt may only be 3-4%.
Unfortunately, such a trend may not last. US trade deficits continue to grow every year. Eventually, US treasury bonds may become less desirable and interest rates will start moving upwards. Double digit interest rates does not seem far fetched in the next 5-10 yrs.
For many, especially those in the hard hit real estate areas such as the California, Nevada, Arizona and Florida, adjustable rate mortgages are common as many owe more than their homes are worth. Paying off adjustable rate debt at 2-4% may not seem like a wise thing to do, but doing this in addition to investing may be a good defensive strategy to put in place.
The reason for this, is when interest rates do start going up, stocks may go down as people start selling stock positions to pay off mortgage debt. For example, a borrower that is has been paying 2-4% may be shocked if interest rates go up to 10%. The natural human tendency is to predict upwards when this happens as was the case when oil reached highs in 2008 and people started buying fuel efficient cars as a result. There will be a sense of urgency in such a case, and borrowers will start prioritizing debt repayment.
For such borrowers, a worst case scenario is one where all investments are in the stock market and debt repayment has been minimized. As interest rates move up, investors may be trying to liquidate positions while stocks are moving downward. Trying to liquidate investments that are decreasing in value to pay off debt payments that are increasing may wipe out the stock market gains.
Not investing in the stock market at all may not be the best choice either as stocks will probably provide a greater return than the current mortgage debt rates and may continue for a number of years. A combination of investing and debt reduction may be the best combination at providing decent returns with lowered risk.
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